Dispersion measures how much the performance of individual stocks diverges from each other. The equity market goes through periods of high dispersion, when the composition of the equity portfolio has a meaningful impact on performance, and low-dispersion periods, when the equity composition matters much less. The AI theme, which has driven up the stock prices of a select group of AI-related stocks, has correspondingly driven equity dispersion to elevated levels.
The chart compares the six-month trailing return difference between the S&P 500 Quality Index and the S&P 500. The S&P Quality Index, a subset of the S&P 500, is comprised of the top 100 stocks ranked by quality metrics (ROE, accruals & leverage). The underperformance of quality stocks is on par with the dot.com bubble experience, which preceded a sharp performance reversal back to quality.
Measures, such as the CBOE S&P 500 Dispersion Index (ticker DSPX), indicate that elevated equity dispersion is likely to persist for a while, but do not predict the types of stocks that will outperform. Staying the course with companies that exhibit strong fundamental and quality metrics has historically worked out well over long-term horizons, particularly when starting point is following a market cycle dominated by thematic leadership and high dispersion.