HI Market View Commentary 06-20-2023
The Big Picture
Last Updated: 16-Jun-23 15:50 ET | Archive
No June swoon, only swagger
It is an age-old truism that you should not try to time the market. We did just that in March, however, casting some aspersions then on the ability of the stock market to trade higher. Turns out we were right — for all of a day.
We published our market view on March 10 when the market-cap weighted S&P 500 was up 0.6% for the year, having surrendered most of a 9.3% gain from earlier in the year, and the Nasdaq Composite was up 6.4% for the year, having relinquished a large chunk of a 17.2% gain from earlier in the year. In discussing those moves, we made it clear that “we would be surprised if the market heated up again soon in a big way.”
The S&P 500 closed at 3,861.59 that day and the Nasdaq Composite closed at 11,138.89. The next session the S&P 500 fell as low as 3,808.86 and the Nasdaq Composite dropped to 10,982.80. Then, in a manner of humble speaking, neither ever looked back. How is that for timing?
Since March 10, the market-cap weighted S&P 500 has surged 14.6% and the Nasdaq Composite has soared 23.4%. Are we surprised? In a manner of humble speaking: “immensely.”
Now, we don’t want to top-tick the market unsuspectingly (like we unsuspectingly timed its first quarter bottom) by saying it is only onward and upward from here, but it seems like it will take some special forces to derail its bullish bias.
Pass the Butter
The numbers don’t lie but sometimes they can be misleading. The moves made by the market-cap weighted S&P 500 and the Nasdaq Composite have been super-charged by the performance of the mega-cap stocks.
To be succinct, the Vanguard Mega-Cap Growth ETF (MGK) is up 36.3% for the year; meanwhile, only three S&P 500 sectors have outperformed the S&P 500 (+15.3%) this year.
Those three sectors are information technology (+42.0%), which houses Apple (AAPL; +43%), Microsoft (MSFT; +44%), and NVIDIA (NVDA; +196%), communication services (+37.3%), which houses Meta Platforms (META; +137%) and Alphabet (GOOG; +41%), and consumer discretionary (+29.7%), which houses Amazon.com (AMZN; +50%) and Tesla (TSLA; +110%).
Those are not the only stocks that have gone up, but given their combined market capitalization of approximately $11.0 trillion, let’s just say the market-cap weighted S&P 500 knows where its bread is buttered.
We can appreciate why these stocks have been so strong. Most had terrible years last year as interest rates were rising, so they were rebound candidates to begin with when the year started. Aside from that, they have industry-leading positions, enviable balance sheets and cash flow, and clear growth prospects.
That qualified them as safe-haven plays in a market that had to contend with the uncertainty of the debt ceiling debate (now resolved), the uncertainty of the mini banking crisis (now far less worrisome), the uncertainty about the economic outlook (still questionable), and the uncertainty about when the Fed will be done raising rates (still to be determined but a hope that it will be soon).
They are quality growth stocks, which should exhibit relative strength in tougher economic climates, but they have been parking spots for investors needing/wanting to stay invested in a stock market contending with a lot of uncertainty. No matter the driver, which includes momentum, the market-cap weighted S&P 500 is going to do well when they are all doing well.
That doesn’t mean, however, that the rest of the market is going to do well. In fact, when June began the Invesco S&P 500 Equal-Weight ETF (RSP) was down 1.2% for the year, reflecting a broader market that was languishing while the mega-cap stocks were flying.
Reading Between the Lines
The month of June hasn’t seen any swoon, only swagger. As of this writing, the Russell 2000 is up 7.2%, leaving it up 6.5% for the year; the S&P Midcap 400 is up 7.2%, leaving it up 6.2% for the year; the Nasdaq Composite is up 6.5%, leaving it up 31.6% for the year; the S&P 500 is up 6.1%, leaving it up 15.5% for the year; and the Dow Jones Industrial Average is up 4.6%, leaving it up 3.8% for the year.
Reading between the monthly and year-to-date return lines, one should be able to tell that “the market” wasn’t doing so well when June began. The best tell in that regard, however, is the equal-weighted S&P 500, which shows no market-cap favorites.
It was down 1.2% for the year, but after a 7.0% gain in June, it is now up 5.7% for the year. That is a solid return on an annualized basis, and it doesn’t include dividends. The performance of the equal-weighted S&P 500 in June is what everyone has been waiting for, as it connotes a broadening out of the participation in the advance that is a good sign.
To that end, we are taking a little bit of solace in the understanding that we called attention to the value-based opportunity in the equal-weighted S&P 500 in The Big Picture article we published on May 12. Since then, the Invesco S&P 500 Equal-Weight ETF (RSP) is up 5.6%. Not to be outdone, the market-cap weighted S&P 500 has increased 7.6% over the same period.
In brief, we had better timing on the equal-weighted call, but still not the better performance. Ideally, that will change, and the performance script will be flipped. We say ideally because the outperformance of the broader market would suggest there is more confidence in the outlook.
That mentality has been a driver of the market in June. Participants have embraced the thinking that the economy can avoid a hard landing and that the Fed is done, or close to being done, raising rates. The Fed doesn’t seem so sure of that, having recently released a dot-plot that reveals a median estimate of two more rate hikes before the end of the year.
Tellingly, the market-cap weighted S&P 500 broke out to its highest level since April 2022 after the Fed released its projections and the equal-weighted S&P 500 advanced to its best levels since March.
All Else Equal
As we asserted in the May 12 column, the equal-weighted S&P 500 offers the more enticing value opportunity for investors. Even with the gains that have been seen in the interim, the equal-weighted S&P 500 trades at just 16.3x forward twelve-month earnings, versus a 10-year historical average of 17.6x, according to S&P Capital IQ, while the market-cap weighted S&P 500 trades at 19.1x forward twelve-month earnings, versus a 10-year historical average of 17.3x, according to FactSet.
The market’s assumption today is that the economy will persevere through the rate hikes, slowing but not recessing (or at least not for long or too deep), that inflation will get back under control, and that the Fed will start cutting rates in early 2024. Additionally, the biggest hope is that corporate earnings growth will accelerate again in 2024.
According to FactSet, the consensus 2024 EPS estimate is $245.44. That would be up nearly 12% from the $219.48 currently forecast for 2023. Arguably, some participants are already dismissing any further earnings weakness in 2023 in favor of a better view for 2024.
That remains a big leap of faith knowing that the lag effect of the Fed’s prior rate hikes has yet to hit home in the economy and that banks are expected to tighten lending standards, yet profit margins are anticipated to improve with cost cuts, supply chain improvement, and lower input prices. The ability to meet those high earnings expectations, then, is apt to revolve around the state of the labor market and the implications there for consumer spending.
Right now, things look reasonably good with an unemployment rate of just 3.7%. Much is hinging on the evolution of the labor market.
In any case, if one were to take the 2024 EPS estimate at face value, the market-cap weighted S&P 500 trades at a less demanding 18.0x earnings when also allowing for the possibility that rates come down next year. The equal-weighted S&P 500 trades at 14.7x.
More value, then, is currently baked into the equal-weighted S&P 500 than the market-cap weighted S&P 500. Therefore, one should be able to limit downside risk if the economy and earnings fare worse than expected by favoring the equal-weighted S&P 500 and still capitalize on upside moves that should work more in “the market’s” favor if the economy, interest rates, and earnings brighten as the market — in June anyway — seems to think they will.
What It All Means
It will be a tall order for the stock market to keep performing the way that it has, although there is a ton of dry powder sitting in money market funds that can be deployed in a risk-on move. It is sitting where it is, though, because interest rates have risen, and capital preservation has been the primary aim.
In other words, there are plenty of doubters still when it comes to the performance of the economy and the stock market. Any attempt to work back toward the prior all-time highs will require a conversion of the doubters, but such a conversion could be an elongated process as market participants respect a history of weaker economic outcomes following a tightening cycle.
To be sure, they will be on watch for special forces that can derail the surprisingly bullish bias for the market-cap weighted S&P 500 and the nascent bullish bias for “the market”:
- Weakness in the mega-cap stocks without a concurrent rotation into other stocks
- Initial jobless claims running consistently above 325,000 and the unemployment rate lurching higher
- The Federal Reserve raising rates more than expected because core inflation sticks at levels well above its 2.0% target
- More acute economic weakness that triggers material downward revisions to earnings estimates
Where will our markets end this week?
DJIA – Bullish
COMP – Bullish
Where Will the SPX end June 2023?
Tue Housing Starts
Wed: MBA, EIA Oil Inventories,
Thur: Initial Claims, Continuing Claims,
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