by Tim Carkin, CAIA, CMT
Senior Vice President, Alternative Assets
It’s been a great ride in stocks lately, hasn’t it?
The S&P 500 is up over 15% this year and up almost 35% over the last 12 months. This week, the Dow Jones Industrial Average eclipsed 35,000 — another “round number milestone.” Surely even the proverbial blindfolded monkey with a dart would do very well picking stocks this year. It’s easy to get excited by these numbers and it’s also easy to feel a bit queasy and uncertain about the numbers. These index gains only tell part of what’s happening in the markets at the moment. Over the last month, the industrial, energy, materials and financials sectors have all underperformed the broader markets. We have seen large outflows from ETFs that follow those sectors as investors move toward growth sectors such as technology and communication services. The Russell 1000 Growth index has similarly beat its Value counterpart by 9%. It was only a few months ago that we highlighted the rotation from growth to value.
We’ve spoken at length over the past few years about market breadth and the number of stocks participating in a rally, such as Facebook, Amazon, Apple, Netflix and Google (FAANG) stocks that have dominated the indices over the last decade. Recently, that narrative has been playing out again. Recent economic news and the rally in the bond market that saw the 10-year U.S. Treasury move from 1.75 to 1.3% has investors looking for changes in leadership. Oddly, it appears that leadership is showing up in the largest companies rather than defensive sectors. Investors are piling into Facebook, Apple and Amazon, all of which are near all-time highs (again). Since many major indices are market-capitalization weighted, the largest companies make up the largest percentage, and the upward trend has continued. But, as you can see in the first chart below, that isn’t the whole story when you look under the hood. As the S&P 500 has rallied within spitting distance of another all-time high, the number of companies that are setting their 52-week highs has dropped (red line). Additionally, the second chart compares the capitalization weighted S&P 500 versus an equal weighted version. As you can see, the average stock is close to flat this quarter while the index has added four percent.
So, what does this mean? The theme of our Investment Outlook this year is “Back to the Future.” The thesis is that in these unprecedented times history can offer insight to investors. Since Jim Cramer coined the phrase “FAANG stocks” in 2013, there have been many times when market breadth narrowed, and a few stocks have led the way. When this was temporary, or when most stocks took a breather before regaining their trend, then markets have continued higher. On the other hand, when the average stock starts to retreat and these large companies are the last standing, the cumulative weight can eventually lead to a pullback in the indices. In this case, stock indices may actually rise while the majority of stocks are red. This would be concerning because it takes less effort to shake the market into a summertime pullback. We believe that the market rotation happening right now is a temporary reaction as investors digest the recent economic news which is softer but still robust. We believe we are in the early innings of this economic cycle and as such, this type of rotation is more indicative of the broader market pausing before resuming its trend. Had we been at the end of an economic cycle, this would be a worrisome indicator.
Source: Strategas
Source: Strategas
Week in Review and Takeaways
Equity markets are again near all-time highs, but upon closer inspection the number of stocks participating is down. The FAANG stocks remain the big holders of market share
The 10-year U.S. Treasury declined for the third consecutive week, ending the week at 1.3%