U.S. equities were mixed last week, with the S&P 500 slightly higher (+0.3%) though NASDAQ posted its second straight week up at least 2.5%, largely driven by AI optimism. Analysts have continued to warn of narrow breadth. Best sectors were technology (+5.1%) and communication services (+1.2%); worst sectors were consumer staples (-3.2%) and materials (-3.1%).
The chart below shows just how narrow the market performance has been this year. Notice the sectors that performed the worst last year have dramatically outperformed the best performing last year even though they are priced much higher than the overall market. Communication services, Consumer Discretionary and information technology have been expensive leaders this year. Through Friday’s close, the 5 largest S&P 500 weights accounted for over 24% of the index. To add to this, both AAPL and MSFT are now each greater than 7% weights, a feature we’ve haven’t seen in over 40-years of data. It’s a passive investors’ dream – mega-cap names carrying the indices to decent returns – but a nightmare for active managers who can’t own enough of those names for various reasons. Sectors that are priced below the market are lagging in a big way. The question is weather to chase the leaders of the market and overpay for short term performance or stick to the good deals in the market and wait for a reversion to the mean when the FED starts to pull liquidity after the debt ceiling debate has been solved.
By Any Measure The Market Is Historically Expensive
Given our collective experience with Q.E. over the past 13 years, the next part of the headline above could easily be – so what? But like gravity in the physical world, interest rates act as a governor of sorts on valuations in the world of finance. Nvidia’s earnings beat was one for the ages and we wouldn’t be surprised if A.I. stocks are valued at “growth at any price” levels for the foreseeable future. Still, if one is playing the odds, it is difficult to get too enthusiastic about a market that is trading historically rich by virtually every traditional measure. A simple regression model could justify a multiple of 17x trailing earnings. Not bad, but a far cry from the current level of 20x. Valuation will always be a poor timing tool, but it does give you an indication of when the odds are on your side. Reaching an agreement on the debt ceiling is, no doubt, welcome news but it will carry with it significant pressure on the Treasury market. The Treasury department will need to issue a lot of debt in the coming months to replenish the Treasury’s General Account. Where on the yield curve Treasury Secretary Yellen decides to issue this debt will be very important for long-term assets like stocks. Massive bill issuance would relieve pressure from the long-end but will be more costly for the taxpayer in the long-run. Issuing long-term debt carries with it risks to financial assets. In some ways, the hardest part of the debt ceiling debate for investors has just begun.
Source: Strategas research and Bob Doll at Crossmark
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