How to use relative strength to gauge a market rally and pick winners

Key Concepts

• Relative Strength: A method of comparing the performance of two markets by dividing one price by another.
• Market-Cap Weighted Index: An index where larger companies have a greater influence on the index’s value. (e.g., S&P 500)
• Equal-Weighted Index: An index where each company has the same influence on the index’s value.
• MAG7: Refers to the seven largest technology companies dominating recent market performance (likely referencing Meta, Apple, Google/Alphabet, Microsoft, Amazon, Nvidia, and Tesla).
• Cyclical Plays: Industries and stocks that perform well during periods of economic growth.
• Breadth Scoreboard: Using relative strength to gauge how widespread market participation is in a rally.

Is the AI Bull Market Broadening? A Relative Strength Analysis

This analysis examines whether the current bull market, driven by Artificial Intelligence (AI), is still concentrated in a few mega-cap stocks (the “starters”) or is broadening to include a wider range of companies (the “bench”). The core methodology utilizes relative strength – a comparison of the performance of different market segments.

Understanding Relative Strength

Relative strength is calculated by dividing the price of one asset or market by the price of another. Tracking this ratio over time reveals which market is outperforming. An upward trend indicates the first market is stronger, a downward trend signifies the second market’s strength, and a sideways trend suggests equal performance. This technique is versatile, applicable to various ETF pairings, such as:

• Consumer Discretionary (XLY) / Consumer Staples (XLP): Gauging risk-on versus defensive sentiment.
• S&P 500 / Russell 2000: Comparing large-cap versus small-cap performance.
• High Yield Corporate Bonds / US Treasuries: Assessing risky credit versus safe credit.
• Gold / Silver: Measuring flight-to-safety versus industrial demand.

S&P 500: Market-Cap Weighted vs. Equal-Weighted

The primary focus of this analysis is the S&P 500, examined through two lenses: a market-cap weighted version (where larger companies have more influence) and an equal-weighted version (where each company has equal influence). The ratio of market-cap weighted to equal-weighted S&P 500 is used as a “breadth scoreboard” to determine if the rally is broadening.

Historical Trends (1990-Present)

The analysis of this ratio dating back to 1990 reveals distinct periods:

• Dot-com Boom (late 1990s): A peak in concentration, with larger stocks dominating.
• 2000-2010: A decline in concentration, indicating a broader rally as more stocks participated.
• Recent Years (circled in the video): A renewed upward trend, coinciding with the rise of the MAG7 and their dominance driven by AI capabilities.
• 2022 Bear Market: During the 2022 bear market, the larger stocks (starters) fell faster than the rest of the index, causing the line to trend downwards.
• AI Bull Market (2023-Present): The line has risen sharply, indicating the mega-caps are leading the rally. However, pullbacks have occurred when these mega-caps paused their leadership.

Expert Perspective: Scott Ladner (Horizon’s CIO)

Scott Ladner of Horizon Investments highlights a crucial transition: the first phase of AI involved building the tools (primarily by the MAG7), while the next phase focuses on using those tools throughout the economy. He states, “The past couple three years have been all about building of of AI capabilities…But these next couple years are going to be about diffusing AI throughout the entire economy.” This diffusion is expected to allow the remaining 493 stocks in the S&P 500 to participate in the rally.

Ladner further emphasizes that the MAG7 don’t need to increase in value for the broader market to participate; they simply need to “tread water” while other stocks outperform. As he puts it, “All they have to do is just sort of tread water or the other ones outperform.”

Actionable Insights for 2026

Ladner suggests focusing on cyclical plays – industries and stocks that benefit from economic growth – particularly in the first half of 2026. These include industrials, retail, and banks.

Data and Statistics

While specific numerical data points aren’t extensively provided, the visual chart of the S&P 500 ratio serves as the primary data source, illustrating the historical trends in market concentration. The analysis implicitly relies on the performance data of the MAG7 companies and the broader S&P 500 index.

Logical Connections

The video establishes a clear logical flow:

1. Introduce the question of market breadth.
2. Explain the concept of relative strength.
3. Apply relative strength to the S&P 500 using market-cap and equal-weighted versions.
4. Present historical data showing periods of concentration and broadening.
5. Incorporate expert opinion to support the argument about the evolving AI landscape.
6. Provide actionable investment advice based on the analysis.

Conclusion

The analysis suggests that while the current bull market is still heavily influenced by the MAG7, there are signs that it could be broadening. The key indicator to watch is the ratio of market-cap weighted to equal-weighted S&P 500. A flattening or downward trend in this ratio would signal a healthier, more inclusive rally. Investors should monitor the performance of cyclical stocks in sectors like industrials, retail, and banking as potential beneficiaries of broader market participation. The “breadth scoreboard” provides a valuable tool for assessing the health and sustainability of the AI-driven bull market.