The first six months of the year have seen a continuation of what we saw for the prior twelve months (i.e., 2023) … a stock market that is unphased by bad news and treks higher. There are intermittent corrections around 5 – 10%, but nothing greater. Maybe we have ourselves a Teflon market?
Over the past 18 months or so, yes. The stock market seems unstoppable despite many unknowns (i.e., the next President, interest rates, etc.). But, if we allow ourselves to put this mini run into context, we can’t forget the bloodletting of 2022, where most portfolios were slashed by 20%+. So, when you include that year in this great run, we really are just catching up to what was lost. In fact, looking at the total of the past 2.5 years, the average annual return is below historical levels (7%+ vs. 10%+). It's still great to be on the upswing, but let’s not lose our minds over this “great run.”
The way this stock market has advanced over the past year is not the healthiest. In fact, how we best define this year’s stock market (so far) is the exact same way we did last year… Top heavy. A handful of stocks are disproportionately responsible for the stock market (as measured by the S&P 500 Index) return. (We posted it here: SmartMunnie).
Last year, Apple was the $3 trillion company that led the charge of the top ten stocks (as measured by market capitalization) and was responsible for 30%+ of the stock market’s return. This year, if you have not heard, this little thing referred to as AI (Artificial Intelligence) is driving massive returns of a not-so-little company, Nvidia, plus six others to make up what has been coined… the Magnificent Seven. These stalwarts are responsible for nearly 60% of the stock market’s 2024 return through June. Again, can anyone say “top-heavy market?”
To put things into perspective, below is a chart comparing the returns of the normal S&P 500 Index (i.e., market-weighted) and what’s called the equal-weighted S&P 500 Index, which essentially strips away the outsized influence that larger companies have on the index’s price/return. The market-weighted index's outperformance of 11% is unheard of (from a historical perspective).
So, naturally, the question is… where does it go from here? It must revert to the mean, right? The equal-weighted and market-weighted indices will come together at some point, right? Yes, but who knows which direction this will go?
Have the Magnificent Seven (and other AI participants) created actual value on the promise of AI, where these current valuations are fair? And thus, ultimately, the other 496 companies (the S&P 500 actually has 503 companies in it) in the S&P 500 Index will climb higher. That’s probably the best scenario for all. Or like in the Dot Com Era, will we eventually see a bust? Thus, will the seven stocks stop levitating and join the other 496 at a more realistic valuation?
Only time and hindsight will tell us the answer to the above. But, as you can imagine, within those 496 companies, we are finding undervalued solid companies. Think about it: They also experienced the correction of 2022 but have not recovered as much as those giant seven stocks. In essence, many are trading at pre-2022 levels, and then some!
For example, the chart below depicts four new stocks added to our portfolio in the past 2 ½ years: Pepsico, a very steady drink and snack company we all know; Veeva Systems, the most dominant customer relationship management software maker in the healthcare field; Lululemon, the most profitable athletic apparel maker; and Zoetis, by far, the largest pet/animal pharma producer.
All four stocks of these great companies typically trade above fair value, but since the beginning of 2022, we have been able to take positions at favorable pricing. They have not returned to positive territory like the Magnificent Seven and others… at least not yet. More importantly, we are getting opportunities to buy great companies at good (to better) prices.
With a presidential election on tap, a likely Federal Reserve rate cut, and who knows what else… the next six months will be interesting. Thankfully, as you know, we don’t make investment decisions in half-year increments. We’ll continue to look for great opportunities that can enrich us further down the road.
Enjoy the rest of your summer!
Marcus
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