The Stock Market Is Repeating a Pattern Last Seen Decades Ago -- Here's What History Says Happens Next

In any given market environment, investors can usually point to a small subset of stocks that account for nearly all of the gains in major indexes such as the S&P 500 (SNPINDEX: ^GSPC) and the Nasdaq Composite (NASDAQINDEX: ^IXIC).

A study published this year found that just 46 of more than 29,000 publicly traded companies accounted for half of the stock market's wealth creation over the last 100 years. Meanwhile, the median return of the entire stock universe, which generated an aggregate total return of 30,000%, was negative 6.9%.

But the current bull market may be even narrower than usual. In fact, the stock market is repeating a pattern not seen since the late 1990s, and it could indicate a big change is coming.

Here's what's going on and how investors could position their portfolios if history repeats itself.

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Not all stocks have been going up in the bull market

Stocks typically move higher and lower as a group. Some stocks move more than average, some less, but most issues move in the same direction as the market. For example, growth stocks might move up more than the market average on up days but fall harder on down days.

The amount a stock moves relative to the market average is called beta. A beta greater than 1 means the stock produces wider swings than the market. A beta between 0 and 1 means its swings are more muted. A beta less than 0 means that the stock moves in the opposite direction from the rest of the market.

"It is exceptionally rare to have stocks with negative betas," Janus Henderson's Richard Bernstein recently pointed out. "The stock market's recent narrow leadership, however, has left a near-record number of companies with negative betas."

Around 70 S&P 500 members have had negative monthly beta over the last 36 months. So, while big artificial intelligence stocks have produced phenomenal total returns in that time, some have seen their prices collapse. The last time we saw such a high percentage of S&P 500 companies exhibiting negative beta was the height of the dot-com bubble.

Here's what happened last time

There was indeed a spike in negative-beta stocks in the run-up to the dot-com bubble, but the number of negative-beta stocks didn't peak until after the bubble popped and internet stocks started to decline. A flight to safety led dozens of stocks to climb, while investors sold internet stocks that had driven the market higher over the previous half-decade.

Unfortunately, there's no guarantee that the negative beta stocks in the run-up of the bull market will remain negative beta stocks once the bubble pops. That poses a significant challenge for investors on two fronts. First, we don't know if and when the bubble will pop. Second, we can't necessarily identify stocks that will exhibit negative beta when it does.

Diversifying among stocks can help mitigate single-company risk, but simply buying negative-beta large-cap domestic stocks today is unlikely to protect against negative catalysts in the stock market in the future. The data merely points to a very narrow bull market that relies on the continued growth of a handful of companies. For true diversification, investors should consider other asset classes or at least look beyond U.S.-based large-cap stocks.

Investors seeking additional downside protection in their equity portfolios should consider buying quality or value stocks. Several value stock ETFs typically exhibit lower (positive) beta. Quality stocks tend to participate in most of the upside of bull markets while falling less during bear markets. There's often a good amount of overlap between quality stocks and value stocks, so make sure you're not overindexing.

There are no free lunches in the stock market. If the bull market continues to march higher, led by just a handful of companies, diversifying away from those stocks will necessarily result in lower total returns. But that may be a price worth paying if it helps you sleep at night.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.