GOLDMAN SACHS: The stock market is hurtling towards disaster, and there's only one thing that can save it

Reuters / Brendan McDermid

• Goldman Sachs closely monitors a measure called "breadth," which assesses the degree to which the market's returns are being driven by a small handful of stocks.
• The firm's breadth signal is flashing yellow, and investors should be wary of a meltdown.
• There is, however, one surprising market dynamic playing out that could help insulate stocks from a surefire selloff.

As the stock market enjoys one of the best earnings seasons in recent memory, an ominous situation is threatening to bubble up under the surface.

It has to do with the market's heavy reliance on just a small handful of stocks, bringing a closely-watched measure known as "breadth" into potentially perilous territory.

Goldman Sachs finds that the top 10 contributors have accounted for 62% of the S&P 500's 7% year-to-date return, which has has breadth hovering near the lowest level on record. And out of those 10 companies, nine are in the tech sector.

This is reflected in the chart below, which shows that a breadth index maintained by Goldman - which provides readings between 0 and 100 - is currently sitting at, you guessed it, zero.

Goldman Sachs

So what's the big deal? Allow Goldman to explain.

"From a fundamental perspective, narrow market leadership typically reflects narrow earnings strength, which is often a symptom of a weakening operating environment," David Kostin, the firm's chief US equity strategist, wrote in a client note.

What's more, the decline of breadth to such low levels has historically preceded meltdowns on both the market and economic fronts.

The period immediately prior to the tech bubble was marked by extremely tight breadth, while similar conditions in 1990 and 2008 preceded economic recessions. Breadth was also notably low during non-recessionary economic slowdowns seen in 2011 and 2016, according to Goldman.

"Usually these narrow bull markets eventually led to large drawdowns when investors lost confidence in the increasingly expensive handful of crowded market leaders," said Kostin.

With all of that haunting precedent to consider, Goldman still thinks the market can come out OK, at least in the near term. And that's because the conditions surrounding this particular instance aren't as troublesome as they were during past periods of turmoil.

It all boils down to the current earnings landscape, which Goldman identifies as a saving grace of sorts for the market. While market returns are highly concentrated into a handful of stocks, Goldman finds that the earnings environment is surprisingly broad-based.

The top 10 S&P 500 stocks account for just 20% of index earnings, which is right around average for the past several years, and just below the 30-year average of 21%, according to Goldman data.

Going forward, it will be up to investors to continue assessing the relationship between market breadth and its earnings-specific counterpart. If corporate profits stay widely distributed by comparison, it should alleviate some worries that a major stock selloff is imminent.

It's when earnings breadth starts dipping that investors should start to worry, so keep your eyes peeled.

Get the latest Goldman Sachs stock price here.