Ring! Ring! It's 7:00 A.M.!
Move y'self to go again
Cold water in the face
Brings you back to this awful place
Knuckle merchants and you bankers, too
Must get up an' learn those rules
Weather man and the crazy chief
One says sun and one says sleet
The Magnificent 7 by The Clash
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As I write this edition of Insights, the S&P 500 index is up roughly 20% year-to-date. However, most portfolios aren’t, which is proving to be a a common frustration among investors this year.
Chasing the S&P 500’s performance in 2023 has been frustrating for many because the majority of the gain in the market has come almost entirely from the seven stocks with the largest concentration in the index in terms of market capitalization. You’d have to eschew diversification-- and thereby take on significantly more risk-- in order to keep up.
By now, you’ve probably heard of the Magnificent Seven. GOOGL, AAPL and AMZN, META, MSFT, NVDA and TSLA account for around half of the weighting of the entire Nasdaq, and the surge in these stocks has dramatically skewed the performance of the broad market index. The performance of the bottom 493 stocks is A LOT different. We can see this visually by comparing the performance of the equal-weighted S&P 500 ETF (RSP) versus the market cap weighted S&P 500 (SPX).
And if Goldman Sachs is right, this phenomenon may continue in 2024:
“Consensus expects the Magnificent 7 will continue to deliver faster growth than the rest of the index. Analyst estimates show the mega-cap tech companies growing sales at a CAGR of 11% through 2025 compared with just 3% for the rest of the S&P 500. The net margins of the Magnificent 7 are twice the margins of the rest of the index, and consensus expects this gap will persist through 2025.
From a valuation perspective, the Magnificent 7 trade at a large P/E premium vs. the rest of the market, but relative valuations stand in line with recent averages after accounting for expected growth. The Magnificent 7 trades at a P/E of 29x, 1.7x the 17x P/E multiple of the median S&P 500 stock. This ratio ranks in the 91st percentile since 2012. However, on an earnings-weighted basis, the Magnificent 7 long-term expected EPS growth is 8 pp faster than the median S&P 500 stock (+17% vs. +9%).”
Goldman may very well be right-- who knows?-- but the asst allocation quilt below succinctly illustrates the risk investors take by chasing last year’s best-performing sector. If you pick any asset class, you will see that they are rarely the top performer for long. A good example in 2023 was that commodities won while the S&P 500 index got monkey hammered down 18%, but if you had chased commodities in 2023, you would have woefully underperformed the S&P 500 index this year.
Top Performing Sectors
Comparison-created unhappiness and insecurity continue to be pervasive in our society. While this has always been the case, social media has certainly become a primary culprit, full of images of people showing off their lavish lifestyles, bragging (lying?) about their outsized returns and generally giving everyone something to which to compare themselves. …It’s no wonder social media users are so damn unhappy all the time.
But make no mistake about it; Wall Street is social media’s partner in crime; it creates this sort of unrest very purposefully. The fact is that money in motion creates fees and commissions. The creation of more and more benchmarks does nothing more than give us more to compare ourselves to, and the end result is that investors remain in a perpetual state of outrage. …And comparison in financial markets can lead to awful decisions.
For example, you should be pleased if you made 12% on your investments but only needed 6%; you probably took less risk and endured less volatility than other investors. Sure, maybe somebody else made 14%, but why would you be disappointed? Does it make any difference to your success?
The reality is that the S&P 500 is still off its 2022 highs by more than 5%. And a diversified portfolio? Fuhgeddaboutit. Japan is off its 2022 highs by 16%, Bitcoin is off its 2022 highs by 18% (and significantly more off its all-time high in 2021), Europe is off 12%. China? Way, way worse. The Russell 2000? Off its 2022 highs by 25%. 20 year Treasury Bonds, off 40%!
Does that mean you want to eschew diversification when it comes to pursuing your long-term investment goals? Absolutely not. Many investors, especially small retail investors, measure portfolio performance over a twelve-month period, but that is absolutely the worst thing you can do, and we see that from the 13 – 24 month results just cited. In a year like 2023, where just seven companies drove the entire S&P 500 index, many investors, thinking they missed out, will want to change their strategy for next year, and as is often the case, that will likely be a mistake.
While we’re still somewhat bullish over the very short term due to the government’s (bs) reporting of a Goldilocks economy, market seasonality, an abundance of underweight fund investors and FOMO, we remain concerned for 2024 about tapped out consumers, “higher for longer” interest rates and higher oil prices in 2024. A substantial risk of slower economic growth next year still strikes us as more than just plausible.
In the current environment, we recommend:
· Avoiding comparisons to any given index
· Adherence to a personal financial plan
· Reasonable diversification
Click here to invest with Chad.
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