June 2023 Market Brief
Drive to Survive
“There is no such uncertainty as a sure thing.” – Robert Burns
The S&P 500 acts like the bull market is in full swing and running hard. Through the end of May, the S&P 500 was up 8.86%, the NASDAQ up 23.59% and Russell 1000 Growth Index up 20.23%. 3 indexes, all up a substantial amount to start the year. But if you step back, and look at what is driving the markets, it turns out it’s mostly 8 stocks, and 3 sectors. Almost EVERYTHING else is struggling to break even and find a positive return on the year. Through May, the Dow Jones Industrial Average was down -0.72% (price return) as well as the Russell 1000 Value and Russell 2000 Indexes also down on the year.
The S&P 500 is a cap weighted index, meaning the larger the company is, the bigger the weighting in the index it becomes. The top 5 stocks in the S&P 500 (AAPL, MSFT, GOOGL, AMZN and NVDA) are now 24.2% of the index, which is the most concentrated and highest reading since 2000. The long-term average weight of the largest 5 stocks is 14.3%. Remember what was happening in 2000? Mania over one sector of the market: technology. Now, these companies are extremely profitable and generate billions in earnings every year, unlike some of the Dot.com era names that were operating on the hope of an eventual profit down the road. Another way to look at the concentration of this market is if you compare the S&P 500 to the S&P 500 equal-weighted (every stock at 0.2% of the index). The equal weighted index is lagging S&P 500 by a rate of -9.02%, which is the most extreme other than 2 instances in the last 35 years: the 2020 drawdown, and November 2008. The large differential between equal weight and S&P 500 also has only happened in or around a US recession since 1990.
AI (Artificial Intelligence) mania is one main driver of market returns this year. NVDA is up 158.93% YTD through the end of May, and more than 250% off its October 2022 low. NVDA makes chips for computers and servers, and the expectation is extremely high for AI demand to boost their revenues tremendously over the next decade. NVDA has a commanding share in the AI chip market, estimated at 60%, and the market itself should continue to grow. Their focus on computer/networking silicon chips, hardware systems, and full-stack ecosystem does make NVDA an attractive pick in a potentially rapidly expanding market. But NVDA now trades at a 189x P/E, and a 50x forward P/E, so this stock is now priced to perfection. Yes, the demand growth could be there, but what happens if it’s a slower adoption than anticipated, or new competitors arrive, or new technology makes theirs look obsolete? What happens if AI gets regulated, or considered too dangerous to keep pursuing? One needs to consider the risks as well as the potential upside.
Any time the markets start to pile into one stock or sector without considering risks and fundamentals, one has to be wary of a bubble. Think Nifty-Fifty of the early 1970’s, the tech bubble of the late 90’s, even bitcoin/crypto, ESG or thematic/ARKK of the 2018-2021’s. It’s a cycle that will repeat: a stock/sector takes off, everyone starts talking about the potential and can’t miss growth, everyone piles in, something [Recession? Regulation? Disruption?] occurs, and valuations normalize.
There are certainly some quality companies at the top of the S&P 500, but price is what you pay, value is what you get. Can the elite eight keep running fast enough to support the whole market? Or will value, small caps, and other sectors finally start playing catch up while the mega-caps take a breather. A bubble and market irrationality can persist longer than most investors care for and expand well beyond fundamentals, however, bubbles eventually all normalize back to trend. Investors should be sensible before piling into this crowded trade at this point in time.