Following a robust second quarter, US equities tacked on more gains in July – despite financial headlines remaining dominated by geopolitical stress, tariff uncertainty, and inflation concerns. As the Wall Street saying goes, stocks tend to climb a wall of worry. The S&P 500 Index rose 2.3% in the month, setting another new all-time high in the process. Technology continued to be the top-performing sector, with Utilities being the only other sector to outperform the S&P 500 Index in July.
This narrow concentration of returns within the Index has been a prevalent reality for some time now. Since the YTD market low of April 8th, only one sector, Technology, has meaningfully outperformed the S&P 500 Index. The Industrials sector just marginally beat the Index, while the remaining eight sectors all underperformed the Index. Talk about a lack of participation across all sectors!
But beyond looking at sectors, a lack of breadth in US equity markets can also be observed when considering cap size.
The chart above shows performance since late 2021 for both the S&P 500 (blue line) and the Russell 2500 Index (red line). The Russell 2500 is comprised of US mid- and small-cap stocks, essentially representing the 2,500 following largest US companies after excluding the S&P 500 constituents. Clearly, the 500 most extensive US market cap stocks have trounced their smaller brethren over the past 3+ years. The S&P 500 appreciated by 43% in that time, whereas the Russell 2500 is barely above break-even at +6%.
However, the concentration of returns goes even further, as even within the S&P 500, the superior performance has come from just a handful of names.
As depicted in the chart above, the 10 largest stocks in the S&P 500 now comprise nearly 40% of the Index – the highest figure in several decades, and much higher than the percentage attained at the peak of the 2000 internet-tech bubble. Again, the main point being that over the last several years the best returns have come from a very narrow, select group of stocks.
And it’s worth noting that when these “Magnificent 7”-type stocks significantly outrun their earnings outlook (as shown in the above chart, with the light blue Earnings line lagging behind the dark blue Market Cap line), the stock prices tend to eventually revert back to get more in-line with earnings.
At this point in the calendar year, it’s always timely to discuss market seasonality. The following chart shows the average S&P 500 returns by month over the last 30 years.
August and September are the only months with negative returns. Many have postulated why this bearish seasonal tendency exists in markets, and it's worth noting that it’s not just a US phenomenon, as it has been shown to occur in many non-US equity markets. The theory that people going on vacation is a popular explanation, but no one knows for sure why this market weakness occurs during this time of year. Nonetheless, it pays to be aware of it.
Lastly, I keep reading murmurings about the start of a new bull market. That after a brief, swift decline earlier this year, equities are once again off to the races. Yet, throwing some shade on this belief are the next two charts.
The first chart shows, reportedly, Warren Buffett’s favorite stock market valuation indicator. The light blue line in the chart reflects the total market cap of all US stocks divided by GDP. Effectively, it’s a ratio that measures the aggregated level of stock prices relative to the size of the US economy. This indicator recently hit a new all-time high, suggesting equity valuations have become significantly extended.
The second chart dates back to 1860, and it shows the Shiller CAPE ratio for the S&P 500. Nobel prize winner Dr. Robert Shiller devised the cyclically-adjusted P/E (CAPE) ratio, which takes into account inflation and smooths earnings over a rolling ten-year period, helping to eliminate cyclical fluctuations. As shown in the chart, the CAPE ratio for the S&P 500 recently reached the third-highest level in its 100+ year history.
While indeed a new bull market for stocks could have started, it would be doing so at already very bloated valuation levels, which is atypical.
That said, and apologies for sounding like a broken record (CD?). Still, we remain defensively positioned in client portfolios as we continue to believe the current environment warrants an emphasis on capital preservation over seeking more speculative sources of returns.
If you have any questions, please feel free to call or email.
The entire team at Measured Wealth wishes to thank you for entrusting us to deliver on your financial goals.
Edward Miller, CFA, CMT
Chief Investment Officer
Measured Wealth Private Client Group
Important Disclosures
Historical data is not a guarantee that any of the events described will occur or that any strategy will be successful. Past performance is not indicative of future results.
Returns citied above are from various sources including Factset, Bloomberg, Russell Associates, S&P Dow Jones, MSCI Inc., The St. Louis Federal Reserve and Y-Charts, Inc. The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Investing involves risks, including possible loss of principal. Please consider the investment objectives, risks, charges, and expenses of any security carefully before investing.
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