The stock market has been on an incredible run lately, but it hasn’t been the entire market, states Nell Sloane of Capital Trading Group.
As of Aug 31, the S&P Technology Index is up 52% over the last year. In that same time frame, Utility Sector stocks are down 6.6%, the Energy Sector is down 43%, and the EAFE Index (developed-country foreign stocks) is about flat from where it was in April…of 2006. And 2008. And 2013.
Foreign stocks have done a lot of moving up and down, so if you were able to time it perfectly by getting in and out at the right times there was money to be made, but as a permanent part of a balanced, diversified portfolio, foreign stocks as a whole have done nothing for 14 years.
Lately, though, “the stock market” has come to really mean U.S. technology stocks.
Investing Starting Points
Given the incredible rise in Technology stocks, it seems pretty easy to make money. Tesla, for example, is up 422% for the year. They make cool cars, and their CEO has a cool-sounding name. However, at least one person bought their stock 4 days ago for $502 per share and has now lost 25% as of last Friday. Nvidia was up 152% since the beginning of the year.
Again, somebody bought the stock early last week and promptly lost 20% over 3 days. No matter what investment you own, the starting point is always one of the most important things. This is why it’s important to look at the stock market value as a whole when investing.
Relationship Between Starting Points and Success
JPMorgan did an interesting study last year that looked at the historical relationship between stock market value and future returns.
No matter how expensive stocks were, it made practically no difference on the 1-year returns. When it comes to investing, one year is well within the “random movement” timeframe for stocks, so the returns were random as well.
This is why it’s difficult to extract much meaning from quarterly or monthly returns. However, when looking at 10-year returns, there was almost a perfect inverse correlation. If you start investing when stocks are cheap, your long-term returns tend to be good. If stocks are expensive when you start measuring returns, your long-term returns stink. This has always been true.
Today, we find ourselves in a situation where the stock market has only been more expensive relative to its earnings twice in its history: just prior to the dot-com crash and early in the Great Recession.
What does this mean? It means that the stock market is expensive today, and if history teaches us anything, it means that there is not a lot of hope for good long-term growth by simply jumping into the stock market.
Does this mean that stocks are about to crash? Not at all, although they certainly could. It just means that the stock market is not an ATM machine. Given the number of new E*Trade and Robinhood accounts lately, there are many people who probably don’t know how important the starting point is, or how happy the market is to take people’s money.
After going pretty much straight up for the entire month of August, the market finally had a bit of a pullback in the first few days of September. Although a 5% pullback can be a little shocking when it happens all at once, it’s really not very significant in the grand scheme of things.
From a technical standpoint, the market was extremely over-bought (and continues to be), so a pullback like this is very normal. There are plenty of non-normal things about the market right now, but a rapid pullback after a rapid rise is not one of them. If the pullback keeps going it could turn into another story, but it’s not there yet.
The non-normal part of the market is the concentration in Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Google (GOOG) and Facebook (FB). The total value of Apple, or the market cap, reached $2.35 trillion last week.
That is higher than all of the companies in the Russell 2000 index put together. For every $1000 invested in an S&P 500 index fund, about $240 goes to the stocks of these top 5 companies.
That means that practically no money is getting channeled to the bottom half of companies like Advance Auto Parts (AAP), NetApp (NTAP), Molson Coors (TAP), International Paper (IP), or any energy stocks.
The indexes were intended to give investors broad exposure to many different companies, but this is no longer the case…and it’s not normal.
Another thing that’s not normal is Tesla stock, which hasn’t even made it into the S&P 500 yet. Tesla is more valuable than Wal-Mart and over twice as valuable as Intel. If, and when, it is added to the S&P 500, it would debut at #9 based on today’s value.
The over-balance in a few tech stocks is not limited to the index funds. Every growth-oriented mutual fund has had to over-weight itself in the same stocks, and retail investors who are attempting to pick their own stocks continue to buy the ones that are getting all the press and that they “know.”
Why does this matter?
Because when investors get spooked, which will happen eventually, everyone has to sell the same stocks in order to reduce risk. It’s well-known that the recent run-up in tech stocks is being driven by retail investors, and many of them are new.
Because of the last 10 years of Central Bank assistance to prop up the markets, many of these new investors consider the stock market to be a safe place to put money.
When they find out it’s not, it is increasingly likely there will be a “run for the exits” sell-off. It’s just what markets do.
Learn more about Nell Sloan by visiting Capital Trading Group
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