Rising Covid cases and a slight uptick in death counts are taking their toll on markets yet again. Overall, the major averages are being held up by a select few mega-cap leaders, but underlying constituents paint a very different story. Some of this makes sense. When growth is scarce and interest rates are low, money will flow to the few winners. PE’s expand, propelled by massive money printing. Check out the central bank balance sheets around the globe below. They aren’t actually dropping cash from a helicopter, but they might as well be.
This increase in money supply has to find a home. Savings account yields are near zero. Over $13 trillion in bonds carry a negative rate. Private equity investors are having a tough time finding decent real estate investments. All of this leads to a large supply of cash funneling into a few select winners. This helped the Nasdaq reach another new record high yesterday.
FANG can be expanded to FANGMAN (Facebook#, Amazon#, Netflix, Google#, Microsoft#, Apple# and Nvidia#). These 7 leaders were up 28% thru the first half of 2020. Combined, their market capitalization is ~$7T, equal to the GDP of Japan and Italy together. The average P/E is 62, albeit depressed by the recession and driven higher by the huge multiple on AMZN#. Apple is the lowest at 30x 2020 estimates. The group is a big reason why investors are holding their own this year, helping the S&P to post only a modestly negative return. Without them, the S&P would be down 7%. In just six months, their weighting in the S&P 500 went from 18% to 24%. That is unsustainable and not indicative of a healthy market. If you didn’t own some of them, your portfolio returns are likely a lot worse.
The real story of the first half that mimics the closure of many businesses and the pain many newly unemployed felt can be seen elsewhere. Even after a solid 2nd quarter, the equal weight S&P was still down 12%. Small-cap funds are worse, with the benchmark dropping 19% thru June 30th. A 12% bounce during the quarter only brings the S&P Value Index to a -17% return this year. Energy stocks are down 38%. Many international indices are at least 20% under water. These markets tell quite a different story than the Nasdaq which posted a positive 16% return through the first half.
Memories of the late 1990’s are likely in our minds. In 1998, unemployment was 4.5%, a 25-year low. The U.S. market was fine, but international economies were in flux. This led to a near collapse of a $126B hedge fund, namely Long-Term Capital Management. A credit squeeze followed which helped cause the Fed to start easing into a very strong domestic economy that didn’t really need any juice. Fear of contagion was the impetus. Remember, the Fed was also cutting rates in 2019, well before Covid hit our shores. Our growth pre-Covid was ramping back up.
The only growth sector in the late 90’s was Technology, as money flowed to repair Y2K compatibility issues along with the promise of dotcom changing the world. The Nasdaq was up 40% and 85% in 1998 and 1999 respectively. Easier monetary conditions and minimal growth stories created a funnel of cash flowing to the winners. Sound familiar? Many stocks outside of the tech sector were down during that time frame. A market collapse in subsequent years corrected the dotcom bubble imbalance, and many leaders back then aren’t even in business today.
We aren’t in exactly the same scenario, nevertheless history does rhyme. Valuations are stretched, but not as excessive. Interest rates are much lower today, leading to higher P/E’s. Money printing now is multiples of past markets. Prior to Covid, GDP rates around the world were stable. Simply put, the mini-bubble now is a fraction of the late 90’s but growing. Markets need to broaden out or risks increase that we are creating excesses that blow up later. That is not our base case, but something to think about if investing in the FANGMAN names today.
Healthy new bull markets include more than just a handful of winners. Wednesday was a good example. The S&P was up nearly 1%, but less than 300 stocks in the index were positive. That was only the second time this happened since 2009, a very rare occurrence and usually precedes a correction
Financial, Discretionary and Energy sectors are near support levels and still feeling the recession. It is critical they hold here or we will have a bigger issue in the second half of 2020. Covid cases and deaths are the primary fear today. Couple that with a likelihood of a Democratic sweep leading to higher taxes and increasing regulations gives pause to certain industries. Biden was in Pennsylvania yesterday touting ending the “era of shareholder capitalism”. A cabinet that includes Elizabeth Warren is also not likely to help the majority of stocks, especially financials.
Until then, we have massive monetary support looking for a home. Winners will take share from those not ready for the new world. Range bound action endures as we await answers to the critical questions. A positive or negative result could create a sizable move in either direction. Maintaining discipline and adherence to asset allocation is the best way to manage risk right now.
TV stars Phyllis Smith from “The Office” and Sofia Vergara from “Modern Family” turn 69 and 48 today, respectively. Hopefully singer Jessica Simpson is enjoying a Chicken of the Sea sandwich on this, her 40th birthday.
James Vogt, 610-260-2214