The S&P 500 or The S&P 495?
Equity markets held up this week despite the collapse in crude oil and base metals prices. Historically the S&P 500 moves in sync with crude oil and base metals – both indicators of aggregate demand and therefore the health of the economy. During this bull market (2009-2017) the weekly correlation coefficient between the S&P 500 and West Texas crude oil is +0.40 and weekly correlation coefficient between the S&P 500 and the Bloomberg Industrials Metals Index is +0.49. In other words, a divergence between equities is not likely be sustainable. If you are bullish on equities, crude oil and metals are presenting a buying opportunity. If you are bearish on equities, crude oil and metals are suggesting that you should stay out of the equity market.
Oil companies make up about 5% of the S&P 500 today and have weighed down the broad market index heavily since mid-2014. Recall that in 2014 the oil sector comprised over 10% of the index and Exxon Mobile (XOM) was the largest company by market capitalization. Of course the culprit is the collapse in West Texas oil prices from $108/barrel in 2014 to $45/barrel today. The sector that has filled the void left by petroleum companies and Exxon is clearly information technology. Or more specifically, just five names: Apple (AAPL), Microsoft (MSFT), Google (GOOGL), Amazon (AMZN), and Facebook (FB), which we will colloquially refer to as the “Big 5”. Today the Big 5 occupy the top five places by market capitalization in the S&P 500, relegating Exxon to the sixth place. Since 2014 the craze for these five tech/internet companies has increased crescendo to the point that the Big 5 have eclipsed the entire S&P 500. While we recognize that the U.S. economy is transitioning from a bricks & mortar economy to a service-based economy, the reflection of this transition on financial markets seems to distort the reality in the U.S. economy today. Is petroleum giant Exxon Mobile, which serves the vast energy needs of our economy, worth $91.3 billion less than Facebook, which produces nothing and makes most of their revenue running ads targeting social media geeks? Is the mega-conglomerate General Electric (GE) which produces everything from air plane engines to medical devices worth $193.8 billion less than Amazon, which again produces nothing and serves only as a middle man in online retail transactions? These are rhetorical questions that we, collectively as investors, need to serious reflect upon.
The first chart below shows the Big 5 company stock prices in an equally-weighted composite index that we created. We compare the Big 5 index to the S&P 495 which, as you can guess, is the S&P 500 with the performance of the five tech companies backed out. We meticulously respected the removed weightings of the five tech companies in recreating the S&P 495.
This is just nuts. Since mid-2013 the S&P 495 has eked out a meager +6.1% gain per annum. The Big 5’s stocks have appreciated at a whopping +57.3% per annum over the same period. The trailing 12-month price/earnings ratio for the S&P 495 has moved from 15.9x in mid-2013 to 20.2x today. The trailing 12- month price/earnings ratio for the Big 3, ex-Facebook (at the time of the Facebook IPO, the company had no earnings, resulting in an artificially high P/E over 200x) and ex-Amazon (which trades at a nonsensical, three-digit P/Es), has moved from 14.6x in mid-2013 to 32.3x today. For kicks, we calculated the Big 5’s P/E taking into account the current trailing 12-month P/Es of Facebook and Amazon. The Big 5 are trading at 59.4 time earnings today. Arguments that the equity market is very expensive today need to be refined. The market is indeed expensive and the top five stocks by market cap are grossly over-valued today.
The next chart shows the recent historical performance of the S&P 500 versus the S&P 495. We can say definitively that five stocks are driving gains for the entire U.S. equity market.
Drilling down to 2017 performance, the last chart shows the performance of the Big 5 versus the rest of the market year-to-date. This market has become a one-trick pony. It has sure been a good trick…as long as it lasts. But the lack of broad market participation concerns us. A market rally built on the performance of just five stocks is undeniably fragile. All the more so knowing that the Apple, Microsoft, Amazon, Google, and Facebook trades are among the most crowded on the planet.
