When John Roque looks at the “markets,” what he sees is very different from that which most observers might deduce. While the health of the economy is often benchmarked by a rising stock market, Roque, a former technical market analyst for George Soros and now fund manager at Key Square Capital Management, sees bifurcation. What is behind the stock market advances is not a broad-based indication of overall business health, but rather the wealth effect that is showered on a few select stocks at the top.

Roque: In a world dominated by passive investing, focus on the top stocks in an index

In an era benchmarked by talk of bubbles – bitcoin, central bank stimulus, and negative interest rates – Roque continues to give the “market” the benefit of the doubt. But increasingly that “market” is reflective of a world in which a very select few are prosperous to a significant degree, while the majority of stocks are languishing in mediocrity.

In a relatively rare occurrence through history, the performance of the top ten stocks in global stock market indexes is significantly driving the performance of the index.

In Spain the top 10 stocks account for 70% of the index performance; on the Nasdaq 100, 10 stocks account for 57% of the index’s gain; In Germany its 62% and in Hong Kong on the Hang Sang the top ten stocks account for 68% of performance.

The “market” isn’t about a broad base of stocks, but rather a select few at the top. “If you have an idea of what these top 10 stocks are doing, you have an idea of what the ‘market’ is doing,” Rogue said on the Financial Sense podcast.

John Roque: Understand the price performance of the top stocks to understand the "market"

To understand the “market” is not to gauge the overall health of business throughout a sovereign region, but rather it is about understanding what is driving the elite stocks. It is with this focus that Roque looks at delivering returns.

If one were to just focus on the top ten stocks in an index, the fund manager, for instance, would outperform the index beta – which is dragged lower by the vast majority of mediocre performers. Looking at the world from this perspective, alpha is not found by finding what is not generally recognized. Rather, it is found by following the most popular, the most elite.

In part, this trend is a self-fulfilling prophecy. With more and more investments being driven by passive exchange-traded funds, the top stocks are clearly benefiting.

With John Roque pointing to 85% of the volume on the NYSE now coming from passive investments – a market dynamic that has never before played such a prominent role -- he points to new drivers of market performance.

“Apple is in 272 ETFs,” he says. “ETFs are now driving stock (prices), not stocks driving ETFs.”

In the US, 5 stocks make up 14.7% of the S&P 500 market capitalization. Understanding what is happening in Amazon, Facebook, Apple, Google and Microsoft is key to understanding the market.

“If you’re not involved in these five stocks you can’t keep up,” Roque said, pointing to a situation that from one perspective wasn’t that different from the days prior to the 2000 “tech wreck” market crash. This is when the likes of Cisco, Intel, Oracle and Microsoft were among a smaller group dominate players that drove stock market performance. When the tech stocks started to crash, so did the market.

But today there are many differences besides the overwhelming impact of ETFs.

John Roquenotes that stock market volume is down, but stock prices are up. The old adage that “volume is the weapon of the bull” doesn’t apply. “You don’t need volume to grow, you just need volume in the biggest stocks to push the index up,” he said.

Noting that what creates a top is the lack of demand but a bottom is created through a crescendo of selling, he points to a key reason why upside deviation is a different risk factor than downside volatility. “Bull markets look like escalators, while bear markets look like elevators,” he said, noting that price tends to move first, then a consensus narrative develops around that price movement, not the other way around.