Market Snapshot
briefing.com
| Dow | 33176.77 | -132.65 | (-0.40%) | | Nasdaq | 12235.84 | -92.84 | (-0.75%) | | SP 500 | 4108.89 | -23.00 | (-0.56%) | | 10-yr Note | -8/32 | 3.46 |
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| | NYSE | Adv 1260 | Dec 1603 | Vol 781 mln | | Nasdaq | Adv 1734 | Dec 2645 | Vol 4.1 bln |
Industry Watch
| Strong: Utilities, Consumer Staples |
| | Weak: Information Technology, Consumer Discretionary, Financials |
Moving the Market
-- Weak mega cap stocks weighing somewhat on the broader market
-- Climbing Treasury yields
-- Ongoing growth concerns and angst about the debt ceiling
-- Regional bank stocks reversing early strength
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Closing Summary
12-May-23 16:30 ET
Dow -8.89 at 33300.53, Nasdaq -43.76 at 12284.92, S&P -6.54 at 4125.35
[BRIEFING.COM] The stock market started the day on a more upbeat note. For most of the session, though, index level price action was negative. There was a late afternoon bounce after the S&P 500 briefly slipped below the 4,100 level, leaving the major indices with only modest losses on a lightly traded day.
Mega cap stocks had been supporting the broader market for most of the week, yet money flows reversed somewhat today. The Vanguard Mega Cap Growth ETF (MGK) fell 0.3% while the Invesco S&P 500 Equal Weight ETF (RSP) closed flat and the market-cap weighted S&P 500 fell 0.2%.
There was not a lot of conviction on either side of the tape today. This followed news that the scheduled meeting between President Biden and congressional leaders to discuss the debt ceiling on Friday had been postponed until early next week as staff members continue to negotiate. Also, it followed a preliminary University of Michigan Consumer Sentiment Survey for May that featured a drop in sentiment and an increase in five-year ahead inflation expectations to 3.2% from 3.0%. That is the highest reading since 2011.
Market breadth showed somewhat mixed action under the index surface. Decliners had only a slim lead over advancers at both the NYSE and the Nasdaq.
S&P 500 sector performance was also mixed with many of the sectors closing near their flat lines. The consumer discretionary (-0.9%) sector was the worst performer due to losses in Amazon.com (AMZN 110.26, -1.92, -1.7%) and Tesla (TSLA 167.98, -4.10, -2.4%). Meanwhile, lingering growth concerns led to the relative outperformance of the defensive-oriented utilities (+0.4%) and consumer staples (+0.3%) sectors.
Regional bank stocks remained in focus today. The SPDR S&P Regional Banking ETF (KRE) had a rollercoaster day. It was up as much as 1.1% and down as much as 1.1%, but ended the session on an upswing with a 0.6% gain.
Treasury yields turned higher in response to five-year ahead inflation expectations rising. The 2-yr note yield, at 3.91% shortly before the release, settled up seven basis points to 3.98%. The 10-yr note yield, at 3.38% shortly before the release, settled the session up seven basis points to 3.46%.
- Nasdaq Composite: +17.4% YTD
- S&P 500: +7.4% YTD
- Dow Jones Industrial Average: +0.5% YTD
- S&P Midcap 400: +0.1% YTD
- Russell 2000: -1.2% YTD
Reviewing today's economic data:
- April Import Prices 0.4%; Prior was revised to -0.8% from -0.6%
- April Import Prices ex-oil 0.0%; Prior -0.5%
- April Export Prices 0.2%; Prior was revised to -0.6% from -0.3%
- April Export Prices ex-ag. 0.2%; Prior was revised to -0.5% from -0.2%
- The key takeaway from the report is that it follows suit with the April CPI and PPI reports from earlier in the week, which showed a moderation in inflation pressures on a year-over-year basis.
- May Univ. of Michigan Consumer Sentiment - Prelim 57.7 (Briefing.com consensus 62.9); Prior 63.5
- The key takeaway from the report is that consumer sentiment has weakened amid concerns about the economic outlook, which threatens to curtail discretionary spending activity that, in turn, would weigh on growth.
Looking ahead to Monday, market participants will receive the following economic data:
- 8:30 a.m. ET: Empire State Manufacturing for May (prior 10.8)
- 4:00 p.m. ET: Net Long-Term TIC Flows for March (prior $71.0 billion)
Market climbs off lows after S&P 500 breaks below 4100
12-May-23 15:35 ET
Dow -45.34 at 33264.08, Nasdaq -63.05 at 12265.63, S&P -13.10 at 4118.79
[BRIEFING.COM] The market is trying to climb a bit higher ahead of the close. The S&P 500 briefly slipped below 4,100, but has been trending higher since.
Regional bank stocks have rebounded somewhat from steeper losses. The SPDR S&P Regional Bank ETF (KRE) tipped into positive territory recently after being down as much as 1.1% earlier.
The 2-yr Treasury note yield rose eight basis points today and seven basis points this week to 3.98%. The 10-yr note yield rose seven basis points today and one basis point this week to 3.46%.
The U.S. Dollar Index rose 1.4% this week to 102.71, moving past its 50-day moving average (102.51).
Energy complex settles mixed
12-May-23 15:05 ET
Dow -132.65 at 33176.77, Nasdaq -92.84 at 12235.84, S&P -23.00 at 4108.89
[BRIEFING.COM] The major indices remain near their lows of the session.
Energy complex futures settled the session mixed. WTI crude oil futures continued to lose ground, down 1.3% to $70.06/bbl. Natural gas futures rose 4.1% to $2.44/mmbtu.
The U.S. Dollar Index continues to climb, up 0.6% to 102.67.
First Solar higher after Evolar AB deal, Gen Digital falls after earnings
12-May-23 14:25 ET
Dow -171.84 at 33137.58, Nasdaq -113.99 at 12214.69, S&P -28.88 at 4103.01
[BRIEFING.COM] The S&P 500 (-0.70%) is in second place on Friday afternoon, just off session lows from this past half hour.
S&P 500 constituents First Solar (FSLR 224.71, +41.52, +22.66%), NRG Energy (NRG 32.53, +1.49, +4.80%), and EQT Corp. (EQT 32.90, +1.00, +3.13%) dot the top of the standings. FSLR moves higher after Evolar AB deal, while NRG continues recent volatility, and natural gas producer EQT gains owing in part to strength in nat gas futures.
Meanwhile, Gen Digital (GEN 16.17, -0.99, -5.77%) is at the bottom of the S&P after last night's Q4 report and Q1 guidance.
Gold little changed on Friday, pressured by dollar, treasury gains
12-May-23 14:00 ET
Dow -165.06 at 33144.36, Nasdaq -109.95 at 12218.73, S&P -28.75 at 4103.14
[BRIEFING.COM] With about two hours to go on Friday the tech-heavy Nasdaq Composite (-0.89%) is the worst-performing major average, now hovering near session lows.
Gold futures settled less than $1 lower (flat) to $2,019.80/oz, pressured by a higher dollar and strength in treasury yields; the yellow metal ended down -0.2% this week, but still up +1.0% on the month.
Meanwhile, the U.S. Dollar Index is up about +0.6% to $102.67.
Looking up at the open
The stock market looks ready to start today's session on a positive note, but it should surprise no one if the stock market ultimately ends today's session on a flat note. That has been its modus operandi so far this week.
Entering today, the S&P 500 is down 0.1% after 26 hours of trading over the last four days. The lack of conviction at the index level, however, isn't what it appears to be. Sellers have been busy bees below the surface.
Entering today, the Invesco S&P 500 Equal-Weight ETF (RSP) is down 1.1% for the week. The offset is that buyers have been busy bees among the mega-cap stocks. The Vanguard Mega-Cap Growth ETF (MGK) is up 1.1% for the week -- and that has made the neutral difference at the market-cap weighted index level.
Currently, the S&P 500 future are up 12 points and are trading 0.3% above fair value, the Nasdaq 100 futures are up 17 points and are trading 0.2% above fair value, and the Dow Jones Industrial Average futures are up 103 points and are trading 0.3% above fair value.
Some rebound action in the regional bank stocks has helped boost trading sentiment while gains in Tesla (TSLA), Meta Platforms (META), Apple (AAPL), and Alphabet (GOOG) are providing some support, helping to mitigate modest losses in Microsoft (MSFT), Amazon.com (AMZN), and NVIDIA (NVDA).
There is also a bid to put a positive spin on the news that the meeting scheduled today for President Biden and congressional leaders to discuss the debt ceiling has been postponed until early next week. According to NBC News, a source said that can be seen as a positive development because staffers continue to negotiate.
It is good to know that talks are happening, but in this matter, talk is cheap. It is action to raise the debt ceiling that is required, and until that action happens, risk tolerance will be reined in.
That is what we have seen so far this week, too. Risk tolerance has been minimal; hence, the mega-cap stocks have outperformed on a safety trade tied to the their strong financial and market-leading positions.
Separately, something that has been weakening -- other than most stock prices this week -- are import and export prices.
April import prices were up 0.4% month-over-month but down 4.8% year-over-year. Excluding fuel, import prices were flat and down 1.9% year-over-year. Export prices increased 0.2% month-over-month and were down 5.9% year-over-year. Excluding agricultural products, export prices rose 0.2% and were down 6.3% year-over-year.
The key takeaway from the report is that it follows suit with the April CPI and PPI reports from earlier in the week, which showed a moderation in inflation pressures on a year-over-year basis.
There wasn't much movement in the market on this news. Then again, there hasn't been much movement this week at the index level where bees have been buzzing, working hard for the money if not the honey.
-- Patrick J. O'Hare, Briefing.com
Gen Digital sells off on another quarter of declining direct customer counts (GEN)
Gen Digital (GEN -6%), formerly known as NortonLifeLock, turned off its 50-day moving average (17.20), heading down toward multi-year lows set in March despite exceeding its Q4 (Mar) revenue forecast and delivering earnings at the high end of its prior projection. Additionally, the cybersecurity software provider, owning banners Norton, Avast, LifeLock, and others, guided Q1 (Jun) numbers relatively in line with estimates, projecting similar EPS and sales as in MarQ.
So why are shares selling off? GEN's direct customer count, which comprises around 90% of its total revenue, contracted by 183,000 sequentially, marking its fourth-straight quarter of declining direct customers qtr/qtr. GEN announced last quarter it was taking the appropriate actions to help drive traffic to its site to reverse this trend, as lower web traffic constricts customer acquisition. GEN reiterated investing in a diverse mix of marketing spend to reach new audiences this quarter to return to direct customer growth. Additionally, management noted that the MarQ decline was the lowest of FY23, signaling a possible bottom. Nevertheless, investors are expressing their lack of patience in GEN's ability to turn around its falling direct customer count, especially given the current unfavorable macroeconomic conditions, setting up a challenging task ahead.
- There were still positives during MarQ. GEN's adjusted EPS of $0.46 came in at the high end of its $0.44-0.46 guidance. Meanwhile, revs of $948 mln, a 32.4% jump yr/yr, surpassed GEN's $935-945 prediction and marked the company's 15th consecutive quarter of growth.
- Also, bookings crossed the $1.0 bln mark for the first time, growing 29% yr/yr in MarQ.
- Also, although direct customers continued to fall off in MarQ, the average revenue per user ticked $0.15 higher qtr/qtr to $7.24, driven by GEN's cross-sell and upsell efforts. Meanwhile, the company's aggregate direct retention rate improved by 1 pt sequentially to 76%, underscoring the positive effects of its actions to increase customer engagement.
- Although it comprises a much lower slice of GEN's total customer count, its indirect customer base grew nicely in MarQ, tacking on 400,000 sequential adds, boosting partner revs by 35% yr/yr to $100 mln.
- GEN's recent $8.0 bln acquisition of Avast, which closed in September, has also been integrating smoothly; CEO Vincent Pilette commented that the two companies' sales and overall infrastructure processes are fully integrated. Mr. Pilette also remarked that the company is on track to achieve $300 mln plus annual cost savings by the end of FY24.
- Product integration is the last piece of the merger and will be a crucial enabler of the total $850 mln in expected revenue synergies.
Bottom line, GEN delivered decent MarQ numbers with encouraging developments underway, including surpassing the $1.0 bln in bookings milestone and healthy progress with the Avast merger. However, investors are discouraged by the continuously declining number of direct customers. Even though management pointed out that the trend appears to be stabilizing, it is unclear when this would occur, especially since GEN is facing an economic environment spurring tightening budgets.
Tesla's Elon Musk appeases investors by naming new Twitter CEO, making small U-turn on prices (TSLA)
For Tesla (TSLA) investors and those who follow the stock, there's plenty of news to sift through this morning as Elon Musk finds himself back in the headlines following last month's disappointing Q1 earnings report.
The most impactful story began with a tweet last night when Musk announced that he has hired a new CEO for Twitter and that she will begin in about six weeks. The Wall Street Journal followed up with an article stating that Linda Yaccarino, NBCUniversal's head of advertising, is the incoming CEO of Twitter.
- To say that Musk's $44 bln acquisition of Twitter has been tumultuous and controversial would be a major understatement. Among a laundry list of concerns, one of the main grievances was that Musk's time and attention would be diverted away from TSLA, which was already contending with COVID-related factory shutdowns, supply chain disruptions, and rising competitive threats. In fact, Musk even admitted last November at the G20 summit that he "has too much work on his plate."
- It would be an oversimplification to say that Musk's takeover of Twitter is to blame for TSLA's recent struggles, but it's still worth pointing out that TSLA shares have plunged by nearly 50% since he first announced his intention to acquire the social media company in April of 2022.
- By handing the baton to Ms. Yaccarino, who has substantial experience and connections within the digital advertising space, Musk can free himself from the considerable challenges that are facing Twitter. According to The Wall Street Journal, Twitter's revenue and adjusted earnings declined by about 40% in December as some key advertisers completely left the platform, and others reined in spending due to macroeconomic concerns.
- While Musk will continue to play a significant role at Twitter as Executive Chair and CTO, his time and energy devoted to turning the company around should diminish considerably. Therefore, in theory, Musk's focus on leading TSLA will increase as the company grapples with another huge recall and tries to iron out its pricing strategy.
In regard to the recall, it will affect more than 1.1 mln vehicles in China and it will involve a software fix for the braking system on each TSLA model.
- The software fix, which will be applied over-the-air and won't require owners to bring their vehicles into a dealership, will allow drivers to turn off regenerative braking and provide more warnings when the accelerator has been pressed for too long or too hard.
- TSLA has had its fair share of recalls lately. In February, it conducted its largest recall in the U.S. when it installed a new version of its Full Self Driving software on approximately 360,000 vehicles.
- These recalls, though, typically don't have much impact on TSLA's financials or its stock price. That's mainly because they involve software updates, rather than costly part replacements in a repair shop.
- Over time the impact of these recalls could accumulate into something more serious and damaging to TSLA's reputation if they become commonplace.
Meanwhile, the company appears to be executing a bit of a U-turn on a price cutting strategy that has not been well received by Wall Street nor TSLA's investors.
- Reuters reported that TSLA modestly raised prices for its Model S and Model X vehicles, which follows last month's price hikes for those models and for the Model Y. TSLA has kept its recent price cuts intact for its least expensive vehicle, the Model 3.
The bottom line is that the combination of Musk freeing up more time and energy to refocus on TSLA and a partial reversal of its margin-eroding price cutting strategy has investors hopeful that TSLA's profit freefall will soon come to an end.
AmerisourceBergen offers defense from worsening economic conditions at an attractive valuation (ABC)
With the healthcare sector historically well-shielded against past economic downturns, we wanted to highlight pharmaceutical distribution giant AmerisourceBergen (ABC), which most recently stood at #37 on our Value Leaders rankings. ABC is among the three titans within the pharmaceutical distribution space, the other two being McKesson (MCK) and Cardinal Health (CAH), which are also on our Value Leaders rankings.
- Demand inelasticity is a reason behind health care typically performing decently during economic troughs. Individuals will always require medical services, and a change in price tends to have little material effect on the change in demand. Pharmaceutical distributors' role as the middle-man in the supply of prescription drugs at a retail shop such as Walgreens (WBA) -- ABC's largest customer at 27% of FY22 (Sep) sales -- allows companies like ABC to particularly see low seasonality and demand elasticity.
- ABC enjoys a fairly large economic moat, as it is one of three organizations supplying virtually all prescription drugs in the U.S. This provides ABC with the capacity to deal with potential future government regulations, bolster its international operations, and maintain its pricing power.
- These attributes were showcased earlier this month through solid Q2 (Mar) numbers. Revenue growth remained steady, expanding 9.9% yr/yr to $63.46 bln. ABC has yet to register a yr/yr decline in sales in over five years. In fact, during the 2008-2009 financial crisis, ABC only saw one quarter where revs fell yr/yr. Also, during the debt ceiling crisis in July 2011, shares edged only modestly lower.
- International sales may have ticked 0.2% lower yr/yr, but on a currency-neutral basis, they jumped 12%. ABC also raised its as-reported FY23 revenue outlook for this business to a 3% decline to flat from a 1-5% decline.
- ABC also raised its consolidated FY23 forecasts, targeting adjusted EPS of $11.70-11.90 and revenue growth of +6-8% yr/yr.
- The population is also aging, with the number of individuals 65 and older to exceed 66 mln by 2026, making it the fastest-growing segment of the U.S. population. Therefore, even though pharmacy distribution via mail is becoming more popular, allowing consumers to no longer have to enter physical retail chains, the population segment that uses the most prescription drugs will likely avoid the e-commerce solution and continue utilizing physical locations.
- Generic pharmaceuticals are margin boosters for distributors, unlike biotech firms which rely on patents to maintain a competitive position. Although generic drug availability will continue to increase as patents expire, potentially putting pressure on prices, ABC believes the increased use of generics will have a net favorable effect on its top-line growth, as volume should help offset falling prices. Also, since generics already account for around 90% of total prescription volume in the U.S., this adverse impact should not be very significant.
Overall, with the healthcare sector offering solid defense characteristics in the event of worsening economic conditions, we view ABC, which boasts a strong foothold in the pharmaceutical distribution industry, competing primarily with just two other firms, as a good choice. Also, its valuation has remained attractive over the past three years, trading around 12-14x forward earnings. Furthermore, unlike MCK, which recently skyrocketed on upbeat MarQ earnings, it is not looking too overbought. Moreover, it has not endured similar struggles as CAH over the past few years.
Sanmina heads lower despite reporting MarQ upside (SANM)
Sanmina (SANM -5.5%) is heading lower following its Q2 (Mar) earnings last night. This EMS provider beat on EPS and revenue while the mid-point of Q3 (Jun) EPS guidance came in above analyst expectations.
- Your first thought on Sanmina might be that it would struggle given the weakness in demand for consumer electronics and weakness in discretionary spend generally. The weak report from Sonos (SONO) yesterday would be a good example. However, Sanmina does not serve consumer markets at all. Its focus is on high-complexity, heavy regulated markets, including industrial, medical, defense, automotive, communications and cloud infrastructure.
- MarQ tends to be a seasonally slower quarter, but Sanmina says demand was stable across most of its markets. Total revenue grew a robust 21.1% yr/yr to $2.32 bln, mostly driven by communication networks and cloud infrastructure. These segments combined to grow 27% yr/yr to $958 mln. Its industrial, medical, defense and automotive segments also did well, combining for 18% yr/yr growth to $1.36 bln.
- Sanmina's top line growth caught our attention. However, non-GAAP operating margin also expanded pretty aggressively to 5.8% from 4.7% a year ago. That may not sound like much, but EMS is a thin margin industry, so that is notable. Sanmina has been expanding its capacity into more profitable projects, including in renewable energy and grid management. Sanmina guided to JunQ margin of 5.5-6.0%.
- The margin expansion was also impressive in light of Sanmina having to navigate a challenging macro environment and supply chain issues. Having a high quality customer base with lasting partnerships has helped counter the macro headwinds. On the supply chain front, Sanmina has been facing shortages over the last two years. However, the supply chain for semi components has been improving, which allowed Sanmina to ship more in MarQ.
- In addition to earnings, Sanmina announced a $200 mln increase to its share repurchase authorization. The company says it has the strongest balance sheet in the industry and it feels very good about its cash position and the lack of leverage there.
Overall, this was a solid quarter for Sanmina. However, we think the stock is lower because the company broke its string of five double-digit EPS beats. The upside was notably more modest this quarter. Also, the stock had risen in the few weeks before this report, so maybe expectations were running a bit higher. Another issues is that Sanmina said it would delay its 10-Q filing as it fixes some historical reporting. That seems to be having an impact.
Beyond Meat's stock offerings cloud its otherwise solid Q1 results (BYND)
Beyond Meat (BYND -17%) is extending its downward trend, sinking to 52-week lows despite topping Q1 earnings and sales estimates and reiterating its FY23 revenue outlook. Quarterly results were solid, with not too many glaring weak points. In fact, shares initially shot up on the plant-based meat producer's Q1 numbers. However, the stock quickly fell back to Earth after BYND filed a mixed-shelf securities offering, plummeting even further on its $200 mln at the market equity offering.
- Still, there are reasons to see the glass half full. BYND showed decent progress toward profitability, improving its adjusted EPS to $(0.92) in Q1 from $(1.58) in the year-ago period. Sales did decline, falling 15.7% yr/yr to $92.24 mln. However, this was still a good improvement from the -20.6% revenue drop last quarter and -22.5% in 3Q22.
- BYND also remained focused on its three central tenets outlined last year: margin expansion/OpEx reduction, cash flow accretive inventory management, and opportunity prioritization.
- BYND started seeing tangible progress through targeting inefficiencies in its operations, illuminated by its cost-of-goods per pound declining 15% yr/yr in Q1. As a result, BYND expanded its gross margins by 650 bps yr/yr to 6.7%, an even greater improvement from the -18.0% margins posted in 3Q22.
- Given the current demand landscape, BYND's inventory levels are currently in excess of demand levels. However, the company has taken steps to work down these inventory levels, sequentially lowering its inventories by nearly 6%.
- BYND is also taking action to stimulate the near-term restoration of growth at select long-term strategic partners. For example, in U.S. Retail, BYND is rolling out marketing programs and promotional campaigns to reengage consumers' interest in plant-based protein. More importantly, BYND is evaluating pricing actions to close the gap between its products and animal-based protein alternatives.
- We view price as one of the most critical factors in spurring demand for BYND's products. Plant-based protein is considerably more expensive than animal protein, which is already enduring softening demand, as Tyson Foods (TSN) noted earlier this week. Given the inflationary environment, consumers are less likely to opt for the plant-based alternative, especially if it commands a higher price tag than beef.
- Encouragingly, BYND reiterated its FY23 revenue outlook of $375-415 mln. Also, due to its continuous cost reduction efforts, BYND projected gross margins to now be 1-2 pts above its prior guidance of low double digits for FY23.
BYND's Q1 results were solid, but its stock offerings are weighing heavily on the share price today. The near-term economic landscape is also looking to remain unfavorable. We think plant-based protein will continue to take a back seat to the more-popular animal protein substitute as long as a significant price gap remains. If BYND can make healthy progress on narrowing this disparity, perhaps consumers will be more inclined to try its products, potentially resulting in additional permanent consumers. However, given that TSN is dealing with lower beef demand, it could take time before consumers are willing to risk part of their squeezed budgets trialing plant-based protein products.
The Big Picture
Last Updated: 12-May-23 15:50 ET | Archive
There is value in the stock market, all else equal
The S&P 500 is up 7.2% year-to-date. The S&P 500 is flat year-to-date. That's not a typo or some AI-generated mistake. Both are correct, yet the indices are not the same.
The market-cap weighted S&P 500 is up 7.2% year-to-date. The equal-weighted S&P 500 is flat year-to-date.
What this tells us, all else equal, is that most S&P 500 stocks are languishing in 2023 while a handful of market-cap behemoths are doing the heavy lifting for the market-cap weighted S&P 500.
A Matter of Opinion
Depending on one's vantage point, there is either nothing wrong with this disparity or something very wrong.
It isn't wrong for anyone invested in a market-cap weighted S&P 500 index fund or ETF, because a gain... is a gain... is a gain no matter how it accrues. If you put money into such a vehicle, you are sitting on a nice, year-to-date gain. That is your money to take, if you so choose, and no one is going to discount you at the door because only a small number of stocks are driving that gain.
On the other hand, some argue there is something very wrong with "the market" because only a small number of stocks are accounting for the nice-sized gains. The "market breadth," if you will, isn't broad.
For some, that spells trouble. The fewer stocks participating in an advance, the more challenging it becomes to sustain the advance, and the bigger the risk there is that there will be a more meaningful setback should the small number of big winners roll over and join the larger number of laggards.
That is the concern these days from a price standpoint.
From an economic standpoint, the concern these days is that fewer stocks participating in the advance signals trouble ahead for the economy. Hence, there hasn't been conviction behind buying efforts, outside of a small number of stocks that would presumably do better than others during an economic downturn.
Overvalued and Undervalued
Another point of contention is that the multiple expansion seen in the mega-cap stocks has left the market-cap weighted S&P 500 trading at a premium valuation. Currently, it trades at 18.2x forward twelve-month earnings versus a 10-yr historical average of 17.3x, according to FactSet.
That's not an egregious overshoot, but then again, interest rates and inflation are a lot higher than they were a few years ago when the market-cap weighted S&P 500 also sported a premium valuation.
The target range for the fed funds rate had been parked at the zero bound in 2020. Now, it is 5.00-5.25%. The 10-yr note yield was sitting near 0.60% then. Now, it is 3.45%. And Core-CPE inflation was up about 0.5% year-over-year then. Now, it is up 4.6%.
The market has adjusted for those changes. Stock prices fell and excess valuations were reined in, although some think it was not enough. We are at a point today where the market-cap weighted S&P 500 is trading at a premium despite further policy tightening, increased geopolitical rancor, the manufacturing sector operating in a state of contraction, consumer sentiment deteriorating, and the specter of a debt ceiling standoff hanging over the market.
Thank you mega-cap stocks!
It is a better and more reasonable look, though, when considering the equal-weighted S&P 500. It is trading with a discounted valuation. Currently, it trades at 15.7x forward twelve-month earnings versus a 10-year historical average of 17.6x, according to S&P Capital IQ.
That's not a huge discount, but it is attractive relative to the 10-year average and certainly relative to the market-cap weighted S&P 500. One can essentially invest in the same market at a discounted price if one is willing to accept that all stocks are created equal.
What It All Means
There is no distinction in an equal-weighted index. Apple (AAPL) is weighted the same as Caterpillar (CAT), as Kellogg (K), as Southwest Airlines (LUV), and so on. There are no favorites.
This could factor favorably in the event there is a market correction that is paced by the mega-cap stocks. That's not to say the equal-weighted S&P 500 won't trade lower, particularly if it is a broad correction, but the equal weighting would temper the losses.
To wit: in 2022, the market-cap weighted SPDR S&P 500 ETF (SPY) declined 19.5%, whereas the Invesco S&P 500 Equal-Weight ETF (RSP) declined 13.2%.
Some think now that the risk-reward dynamic for the market-cap weighted S&P 500 is unfavorable, especially with many forecasts calling for slower growth and reduced earnings prospects in coming months. Additionally, the Fed doesn't sound as if it is inclined to cut interest rates anytime soon, saying a rate cut before the end of the year would not be appropriate if its own forecasts are correct.
All else equal, though, an equal-weighted S&P 500 fund or ETF should have some appeal for participants that have to, or want to, put money to work in the stock market.
- It neutralizes the influence of one stock, or a small number of stocks, having a disproportionate effect on returns, which is a benefit in the event of a correction in the mega-cap stocks.
- With the equal-weighted S&P 500 trading at a discount to its historical average, there is more value to be had than in the market-cap weighted S&P 500, which trades at a premium.
- One isn't necessarily overpaying for "the market" in front of a potentially more challenging period for earnings growth.
- A catch-up trade could manifest itself in an equal-weighted S&P 500 should the economic, earnings, and interest rate outlook turn out to be friendlier than expected.
-- Patrick J. O'Hare, Briefing.com
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