Talking Points – July 2021

July 28, 2021 – Comparing Mega Caps to History

It is no secret that large cap U.S. stocks have dominated for years. They have done so for so long and to such an extent that there has been an increasing frequency of comparisons to past large cap bubbles. Most notably would be the Nifty Fifty bubble of the 1960’s to 1970’s and the tech bubble of the late 1990’s. 

In today’s chart, we have a big picture comparison of those eras versus today in terms of the 50 largest stocks.

Source: Strategas Research

What this chart leaves out and many with current bubble concerns ignore is the dramatic difference in interest rates during these periods. Throughout the Nifty Fifty period, investors could purchase a 10-year U.S. Treasury bond and receive a 6-8% yield. During the tech bubble it was 4-6%, with both eras also offering attractive cash rates. Today, a 10-year U.S. Treasury will yield only 1.25% and cash earns 0%.

At any given time, there are many factors affecting financial markets, but today it seems the most obvious one remains by far the most important. What interest rates do in the quarters and years ahead are likely to have a huge influence on stock prices and valuations.

July 21, 2021 – Earnings Strength

As stocks endure the ups and downs of the typically more volatile summer months, it is important to take a step back and look at a key fundamental factor. While it is still early in this earnings season, so far companies are reporting earnings that have beaten analyst estimates 85% of the time. This is on pace for a record and well above the 71% average beat since the financial crisis in 2008.

The earnings strength is particularly important now, as many have been starting to factor in a sharp drop in economic growth the second half of this year. Earnings, the economy and the recent declining interest rates are all connected in various ways and currently telling somewhat different stories. It will be noteworthy in the months ahead to see which is right.

July 14, 2021 – The Simple Reason Stocks Have Gone Up For Years

For retirees, or really anyone wondering what to do with their excess cash savings, the past decade has been a real challenge. Since the depths of the financial crisis in 2008, the Federal Reserve has kept interest rates low to boost the economy. In fact, today short-term rates are at 0% and a 10-year U.S. Treasury offers less than 1.5%.

The chart below, shows how much income a $100,000 savings account would have earned over the years. Right now, it is nearly zero, but just before the financial crisis and during the tech bubble of the late 1990’s savers could have earned $4000 to $5000 per year. That made bonds and money market accounts an attractive alternative when investors became concerned about the stock market. Perhaps as a result, those bear markets were deep and long lasting.

Source: JPMorgan Asset Management

Now, the interest earned is far below the blue line representing what is needed to match inflation. With so few attractive opportunities to earn income conservatively, many investors over the past decade have moved out on the risk curve and allocated savings more towards stocks. This has paid off well and has perhaps been the simple reason stocks have gone higher for so many years in a row. Whenever there is a stock price dip cash earning nothing elsewhere comes pouring into the market.

This trend can’t last forever, as the Fed will at some point try to normalize interest rates. We continue to feel quality stocks will offer attractive returns in the long run. However, it is important for investors to not put money they may need in the short-term at risk. As always, a sound financial plan and investment process will help reduce the stress and resulting behavioral mistakes that market volatility can cause.

July 7, 2021 – Is the Mega Caps Size Justified?

For years, the U.S. stock market has been dominated by the largest companies. Not always of course, as small caps and cyclicals have led during periods over the past year. However, the mega cap names that most of us know and often personally use seem to continue to grow. Because of their size they are often considered too big and too expensive. In fact, the ten largest stocks in the S&P 500 are now about 29% of the entire index, which exceeds the 1990’s tech bubble that was dominated by large stocks.

Source: JPMorgan Asset Management

However, the earnings contribution from these ten companies at over 30%, now exceeds their weight in the index. Also, the top ten now generates about double the amount of earnings as during the tech bubble.

Source: JPMorgan Asset Management

It appears to be a different era dominated by a handful of large companies. Historically, the list of top ten largest varies greatly each decade. Could this next decade change that pattern and the list remain fairly consistent? There will be times when stocks and even the companies stumble and regulators will try hard to break them up, but the message of strength remains clear for now.

Source: Greg Towner, CFA, CMT