We are only halfway through February, but so far 2020 looks like a repeat of 2019. How so? Large caps are outperforming small caps, growth is outperforming value, tech is the best performing sector, and the U.S. is outperforming international (for about ten years now). If the U.S. economy maintains its current trajectory, these trends are likely to continue.
TOO MUCH MONEY CHASING TOO FEW STOCKS?
Is there a shortage of stocks? Available investment dollars consistently grow over time, but the number of stocks available to purchase has shrunk considerably. When I first got into this business in 1982, there were about 17,000 publicly traded stocks in the U.S. Now there are approximately 4,000. In dollar terms, the S&P 500 has a market cap of $25 trillion, while global household assets worldwide are about $300 trillion (source: Fundstrat Advisors). The U.S. stock market is considered the safest trade for global equity investors when times get tough – either through slow global growth or external shocks like the coronavirus. We question whether there is enough S&P 500 to go around since foreign investors tend to buy S&P 500 stocks when they come here to invest. Maybe this is one reason why the U.S. bull market has become the energizer bunny (of course, strong U.S. fundamentals are the main reason). Will it continue? It just might. This supply/demand imbalance won’t prevent corrections or bear markets but may lessen their intensity.
Much of the money currently funneled into the U.S. equity markets from both U.S. and foreign investors is invested in index funds that are structured to replicate a benchmark like the S&P 500. That means the largest stocks get the largest allocation of new investment dollars which pushes large company share prices higher and higher. Some call this dangerous and a bubble waiting to pop. We don’t think so and here is why: The five largest stocks in the S&P 500 account for about 17% of the S&P 500 index, about the same weighting as the market top in 2000. However, today’s top five are growth companies that have P/E multiples only about 5.5 multiple points above the rest of the S&P 500. Only one stock (Amazon) trades for more than 30 times earnings. In 2000, on the other hand, the average multiple of the five largest stocks in the S&P 500 was more than 33 multiple points higher than the average for the rest of the index, and not a single stock traded for less than 30 times earnings (source: Bespoke Investment Group).
Another consequence of indexing is that sector weightings have become more concentrated. For example, the technology sector’s weighting stands at just under a quarter of the entire S&P 500. That’s more than ten full percentage points more than healthcare – the next closest sector. And technology’s weight is more than four full percentage points higher than the combined weighting of the five smallest sectors. Should we be alarmed by this? It does make us feel a bit uncomfortable but we understand why it is so. Investors will always go to where the growth is and that is tech today (which is comprised mostly of software and semiconductor companies). Until tech growth slows down on a relative basis, this heavy weighting is likely to continue.