By one measure, the S&P 500 index, excluding dividends, has slipped into negative territory for 2023. In another, the S&P 500 is up 9.5% since January 1, 2023. The difference is whether you look at all 500 stocks and weigh them equally (i.e. take a simple average of the 500 values) or use a weighted average where the largest market capitalizations account for a larger share of the index.
The very largest S&P 500 stocks, Nvidia, Microsoft, Alphabet, Apple, Amazon and Meta, all tech stocks riding the AI wave, are up $3 trillion in market cap, the remaining 494 stocks have lost $286 billion in value in 2023. Some have compared the S&P 500 as similar to Michael Caine’s quote about ducks: “calm on the surface but paddling like the dickens underneath.” Even so, using the market cap weighting, the S&P 500 is on the verge of exiting a bear market that started a year ago.
But what about the other asset styles that are part of the equity asset class? This includes value stocks, small cap and mid cap stocks, as well as international and emerging markets that should all be part of a diversified portfolio.
The S&P 500 contains both growth and value stocks. Growth stocks are companies that are growing their revenues and profits at faster rates than the market at large. Value stocks are companies that are considered to be trading below what they are really worth and thus should provide a superior return. Value stocks are often larger, well-established companies whose fundamentals would indicate their value in the future should be more than their current price.
The markets in 2023 reflect the current differences in growth and value. For the first four months, the S&P 500, primarily driven by the large tech growth stocks above was up 9.17%. Value stocks were up only .7%. As the “debt ceiling crisis” kept getting closer to June 1 and the possibility of a government shutdown, value stocks, as represented by VVIAX (Vanguard Value Index Fund), were down 4.1% in May while the S&P was up .43%. In the first three trading days of June, the S&P 500 was up 2.27% and the value stocks were up 2.30%.
Bank stocks, which are value stocks, were hit hard by the collapse of Silicon Valley Bank on March 10th with many losses in the range of 30-50%. Since mid-April, most bank stock values have been increasing. Many believe that the failed banks were the result of incompetent management and poor risk controls. Since the Great Recession in 2008-09, banks have had higher capital reserves and more limitations on their ability to take huge risks. Further, the Fed has said it will support troubled regional banks.
At the same time, small and midcap stocks, which tend to outperform large-caps during the early stages of bull markets, typically underperform when prices are falling overall. Small caps were up only .89% by the end of April and lost .92% in the month of May. In the first three days of June, small caps were up 3.28%.
Hopefully with the debt ceiling crisis behind us, the markets will start to move towards establishing a new business cycle. Business cycles are typically one to ten years. The expectation of a new business cycle increases market values and produces bull markets. The last bull market started March 9, 2009 and lasted until March 2020 when Covid hit. In the first year of that bull market, small cap returns produced a 93% return and the S&P 500 a 71% return. The returns for the second year of the bull market were 55% per year and 42% per year respectively. It took ten years for the S&P 500 to catch up to small cap stocks with both earning 17% per year over a ten-year period through March 9, 2019. Of course, past performance does not guarantee future results.
The graph below shows current P/E (Price/Earnings) Ratios and historical values by sector. Large cap growth stocks are at 122% of historical P/E ratios while large cap value stocks are at 79% and small caps blend are at 77%. The markets have really piled into anything related to AI this year. Nvidia’s current P/E is 205 (over 11 times the 17.82 historical P/E average of the S&P 500 Growth). At the moment, markets are NOT moving on fundamentals. However, fundamentals do count and so portfolios need to be positioned accordingly.
Yes, the debt ceiling crisis is behind us now, but we still have volatility and an economy and market with both positive and negative signals. No one knows the future. We do know that fundamentals matter and when the positive expectation of the next business cycle is clear, equities of all types will respond well, particularly those that are currently undervalued. We love our work at DWM and are always happy to discuss investments and financial planning with our clients and friends. Please give us a call.