The recent pullback in the S&P 500 and pick-up in volatility is a reminder that markets (and investors) sometimes can get ahead of themselves. No matter how strong a company is performing, or how robust the economy, market resets happen, and are a natural part of investing. It’s important to remember this, maintain a long-term view, and avoid being caught in hype cycles.
Assessing the S&P 500 Today
Expectations can get ahead of reality, especially when you have an environment that is shifting the landscape of the traditional work environment and expediting technological change. Great companies are formed during periods of chaos and volatility, but sometimes the expectations investors have for those companies can become too lofty, too soon.
Today we are living through a market and economic environment that is rewarding modern technology-savvy companies, and forgetting the rest. It’s creating broad dispersion in the S&P 500, and this dispersion in markets is what has caused increased concentration in S&P 500 returns (S&P 500 Concentration Hits All-Time High) and now, the market pull-back.
To create some perspective around the current state of the market and what’s going on, let’s examine a few pieces of S&P 500 and economic data.
First, S&P 500 earnings. Despite the market optimism, S&P 500 forward looking earnings estimates remain 17% below where they were before COVID happened. Investors have been quick to seize on all commentary / metrics from management teams suggesting a rebound, but sell-side analysts remain more reserved. This investor exuberance over the future has led to a modest disconnect in the S&P 500, as overall earnings remain broadly depressed outside of specific industries and companies.
Second, performance. As of today’s close the S&P 500 is up 3% for 2020 (price only basis), and 7% below its all-time high achieved less than one week ago. Furthermore, the market is up nearly 50% from its COVID-low. Performance like this would suggest a rapid recovery in earnings and economic activity, however as the earnings estimates show, this hasn’t occurred yet.
Sticking with performance, looking at the individual S&P 500 sectors dispersion is pronounced, as outperformance has been very technology-focused post-COVID. Specifically, technology-driven sectors and technology-savvy companies are meaningfully outperforming more traditional business sectors.
And finally, valuations. Strong S&P 500 performance without meaningfully higher earnings estimates means market valuations have increased. Earnings expansion like this, no matter the economic environment, would likely be a cause for concern and pause.
As many analysts and investors have pointed out, S&P 500 forward looking valuations before the recent sell-off stood at 24.8x – well ahead of their historic average of 16.4x. And even after the recent pullback, the S&P 500 is still trading at 23.1x.
And digging into the S&P 500 sectors here, sector-specific valuations further suggest that investor sentiment is largely in technology-driven companies. Nearly every S&P 500 sector is trading at a higher valuation than it was at the end of 2019, despite most having lower earnings expectations. (Note: The energy sector is an outlier here as the significant increase in valuation has come as BOTH earnings and stock prices have steeply declined).
Putting The Market in Perspective
Which now brings us back to the the market’s recent pullback.
Since the S&P 500 bottomed on March 23rd the median performance of its constituents is +52%. And since September 2nd the median performance of its constituents is -4.5%. Looking at the performance in this regard is helpful, as it puts the market in perspective. Headlines of Apple declining 14% are polarizing, but remembering that Apple is up 101% since March 23rd.
Many great companies like Apple may continue to go up, but there will be volatility along the way. Markets are often sensationalized, especially when faced with volatility an uncertainty. What’s important to remember is the context around everything. Any long-term investor must be able to withstand periods of negative returns, increased volatility, and stock pullbacks. However, keeping these declines in the context of the overall performance is important, because in the long-run markets historically have worked through these periods and rewarded those who were prudent.
ENDNOTES
Disclosures
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.