— Record market highs we are experiencing relate more to capitalization weighted indices than strength in the average stock composing those indices
— Tear apart the numbers and the results show we have been in a significant downturn in the simple average stock since February 2021
— “Aren’t you worried? The market just keeps going up and up!”
— Best offense, own average stocks!
S&P 500 Index: size matters here
The index that many of us use to gauge the activity of the broad stock market, the S&P 500, does not give an accurate picture because of market performance because it is capitalization-weighted. Simply stated when calculating the index each company’s total stock market value (market capitalization) is added. That sum is divided by 500 to determine the value of the index. The size of the company’s market cap in the index makes a huge difference in the performance registered by the index. A loss of 10% on 10 $100 million dollar components of the index can be completely offset by Apple going up 10% with the average for all 11 companies showing a positive 10% gain.
According to Ed Yardeni, founder and President of Yardeni Research, as of August 6, 24.9% of the S&P’s total market value is being generated by 6 stocks, the FAANGMs (Facebook, Apple, Amazon, Netflix, Google and Microsoft). They represent $9.4 trillion of the S&P’s 37.1 trillion market. This is probably a big caveat emptor’ moment.
The attached report is dated August 6,2021. It carries no text, just graphs. I believe it is worth serious consideration. One little teaser: since the beginning of 2012 the FAANGM’s are up 721.4% with th S&P ex-FAANGMs up only 147.6% (Chart #4). Please don’t get me wrong here. These are great companies. They just may not be great values.
What’s really been happening to the market since February 2021?
Contrary to the popular belief that ‘the market’ has been day-after-day making new record highs digging below the surface, ‘the market’ has been doing much worse. Performing calculations with simple average stock prices (not market-cap weighted) in the NYSE composite index you’re down 17% from the February peak. The NASDAQ composite and NASDAQ 100 are down 26% and 10% respectively. This has been a stealth correction. These results were derived by taking a simple average of the prices of all the components each of index.
All of this poor performance was masked by superlative action in the large cap (heavily marketed-cap weighted) tech and information tech companies. I owe these insights to JC Parets, CMT (Allstar Charts) and his participation on a podcast with Josh Brown and Micheal Batnick (The Compound and Friends #10). I commend the attached podcast to your attention.
“Aren’t you worried? The market keeps going up and up!”
This is an actual question that I received last week from an individual who knew my background with investments. And, I guess it is very understandable given the wealth of pundit opinion and calls for a retracement (or worse).
“20 strategists predict the time and size of stock markets’ next big tumble”
“Citi downgrades U.S. stocks, saying higher rates will pressure tech shares”
This is, as usual, a lot of noise but people are listening and recency bias has them looking back at spring 2020 with many still reeling from their experience in 2008. I find those people who experienced the financial crisis and the Covid 19 market break have a lot more money and are very much more skittish about the market than the Robin Hood crowd. From my perspective this is very healthy … no froth here accept for the newbies..
The Citi headline above has it half right but they miss the point that what is bad for tech shares, a stronger, more resilient economy with higher interest rates and inflation, is good for the majority of stocks. It does not favor the high growth, high PE stocks where many investors have felt safe in a period of economic uncertainty.
The answer to my sub-heading question is NO. I am not worried. A large part of the market has already corrected. I guess I also should have pointed out that most people are not very good at picking out tops and bottoms. Fifty-plus years of experience tells me I’m not good at it either.
The best offense: own some average stocks!
Own mid-cap, small-cap and value stocks, those stocks that have been punished by the economic uncertainty brought on by the Covid delta variant. Many have already experienced significant (10, 15 and 20% corrections) since their peak in February. Because of the preeminence of large cap/ growth investing these classes have underperformed for years. The Citi analyst who penned the above-referenced report may be absolutely right about the performance of those indexes that tilt to large-cap growth. In a period of rising rate these names will not hold the same attraction to investors.
We’ve all heard the old market maxims, ‘no tree grows to the sky’ and ‘it is a market of stocks.’ Unless it is different this time (famous last words) these maxims will prevail.
What’s your take?