The Stock Market’s Bad Breadth

Fewer companies have been driving equity market gains in 2026. Our CIO and Chief U.S. Equity Strategist Mike Wilson looks at what investors should make of the narrowing rally as the year enters its final stretch. Read more insights from Morgan Stanley.----- Transcript -----Mike Wilson: Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing the Market’s Bad Breadth.It's Monday, September 28th at 11:30 am in New York. So, let’s get after it.The market is up this year. That's the good news. But over the last six weeks, I've been watching something that’s giving me pause. This rally has been carried by a shrinking group of stocks.More than half of the Russell 3000 is at least 20 percent below its June highs and the S&P 500 forward multiple has fallen to 19 times, close to a new low for the year. Meanwhile, earnings growth is still running in the mid-teens for the median stock and revisions breadth is approaching cycle highs for the S&P 500. That is not complacency. It is a market that has already done a lot of work to price higher energy costs, a tighter Fed, AI disruption, questions around returns on capital, and geopolitical risk. Last week on the podcast, I noted that this is classic mid-cycle behavior. Earnings are absorbing lower valuations, and quality is taking the baton from the early-cycle winners. Groups that have led powerfully from the rolling-recession trough have been among the weakest areas recently: Autos, Semis, and short-cycle Industrials. That is what tends to happen when the cycle matures and the Fed turns less friendly. The market stops paying for high beta. And starts rewarding free cash flow, stable margins, operating efficiency, and earnings that are still being revised higher. That is why I continue to favor large-cap quality, particularly asset-light, services-oriented, and fee-based businesses.Having said that, there is still one problem to resolve. Breadth improved through most of the summer even as crude and yields moved higher. The deterioration came after Jackson Hole. That’s when markets began discounting a more hawkish Fed reaction function. The percentage of S&P 500 stocks above their 200-day moving average fell from roughly 75 percent to below 50 percent, while the index held up much better. That divergence cannot persist forever. Either breadth catches up to price, or the index comes down to meet breadth. If bond volatility does not settle down soon, it could spill over into equity vol and we would see the S&P 500 price come down about 5 or 10 percent.  Frankly, I would welcome it. A final index-level correction is often how a multi-month correction beneath the surface ends.There has been a lot of focus on the Fed’s recent pivot to rate hikes. However, the two-year yield is already above the level implied by the Fed’s projections. To me this suggests the bond market has been leaning too hawkish in the near term. The bigger uncertainty is how the new Fed Chairman approaches liquidity and the balance sheet. He is more of a monetarist than his predecessors, and markets are still trying to understand what that means in practice. My expectation is that the Fed ultimately provides liquidity if financial conditions tighten too far. But markets may test that resolve first. Bond volatility, funding stress, and whether equity volatility follows are the key signals. If those pressures ease, breadth can catch up and drive the market higher. If they do not, the index probably has more correcting to do.There is also a new, constructive story developing for investors: AI adoption is moving from promise to practice. Companies with higher AI adoption are seeing stronger margins and earnings trends, but consensus still assumes many of those benefits fade in the out-years. We think that’s too conservative. Productivity gains tend to compound, not immediately disappear. Earnings momentum is broadening from enablers to adopters, while adopter valuations have reset to more attractive levels. That supports a barbell approach – own select enablers where earnings durability justifies the premium, but increasingly own adopters where improving fundamentals are not yet fully reflected in expectations.Bottom line, the market is not ignoring risk. It has priced the risks through lower valuations, weaker breadth, and major leadership rotations. What remains unresolved is the gap between a resilient index and a much weaker average stock. The answer is that we probably see breadth improv