by Peter Jones, CFA
Senior Vice President
This week, Federal Reserve Board Chair Jerome Powell announced that later this month the Fed will begin “tapering” its asset purchase program now that the economy has moved past the need for extraordinary stimulus. As a reminder, to combat the recessionary effects of the pandemic and stimulate the economy, the Fed reduced interest rates to 0% and reintroduced an asset purchase program to the tune of $120 billion per month. By any measure, this is a remarkably large stimulus program. With strong economic growth, falling unemployment and decade-highs in inflation, the time has come for the Fed to take their foot off the gas. However, Fed guidance only indicates that asset purchases will be reduced by about $15 billion per month and interest rates will remain at 0%. In other words, while this move represents a tightening of policy at the margin, monetary policy will remain extremely accommodative given that $105 billion worth of assets will continue to be purchased by the Fed monthly. As such, our view continues to be that interest rates will continue their gentle rise but remain in a historically low range. For example, the 10-year U.S. Treasury yield has already doubled this year yet, in the same period, is less than half the rate of inflation. In real terms, you are losing money by owning bonds at prevailing interest rates. While we remain underweight bonds, fixed income is still the cheapest portfolio insurance you can buy.
On the fiscal side of this week’s policy news, we saw yet another delay in the passage of broad tax and spending legislation and a separate infrastructure bill. Despite pressure for the Democrats to get something done in the face of notable losses in state and local elections, voting was once again postponed. With Democrats controlling all three branches of government, it has been surprising to see this lack of conviction in moving legislation through the chambers. This time, moderate Democrats have requested a non-partisan evaluation from the Congressional Budget Office that examines the long-term costs and deficit implications of President Biden’s $1.75 trillion social policy and climate change bill.
With important fiscal and monetary news leading the headlines this week, how did the market react? By yet another all-time high. After a weak September, the market has marched back to new highs, climbing more than 9% since the lows of October 4. Furthermore, the market has been achieving gains in what has become a very familiar manner: the strong getting stronger. That is, recent market advances have been led by behemoth technology, internet and growth stocks. Most notably, Tesla has increased by 57% in the last month alone. In dollar terms Tesla’s market value has increased by $450 billion in this period. As a reference, the combined market capitalizations of Ford, General Motors and Toyota total $452 billion. This is just another example of how the direction of the broad market has become increasingly dependent on the direction of a select few stocks.
In the last five years, the S&P 500 has increased 95%, which is a phenomenal return and above any rational projections for what to expect over any five-year period. While impressive, these returns pale in comparison to the large technology and internet stocks. Namely, Google, Facebook, Apple, Microsoft, Amazon, Netflix and Tesla. The median return of these companies in the last five years is 437%. In 2016, these companies accounted for 13% of the S&P 500. Since then, these companies now make up 26% of the S&P 500. More than one quarter of the entire U.S. Large Cap market value resides in these seven companies. Even more amazing, of the 95% S&P 500 return in the last five years, 56% is solely attributable to these companies. In other words, of the 500 companies that make up the U.S. Large Cap market, seven of them have accounted for 56%, and 493 of them have accounted for the other 39%. This has been a narrow, mega-capitalization growth market.
Our heritage at Ferguson Wellman is one of favoring companies with low valuation and avoiding those that do not earn profits or are otherwise extremely expensive. That said, several (but certainly not all!) of the aforementioned companies actually have roughly average valuation compared to the S&P 500. Said differently, the pace of stock price appreciation has been fully justified by the immense profit growth seen across the large-cap technology and internet space. While we do expect these companies to converge with the market as interest rates rise and the law of large numbers slows profit growth, we see little resemblance of today’s mega-cap growth market to that seen during the technology bubble in 2000.
Takeaways for the Week
There were notable policy developments both on the fiscal and monetary side of the ledger this week
The S&P once again digested news by achieving new all-time highs
The market continues to be dominated by mega-capitalization technology and internet stocks