A Tale of Two Markets
"It was the best of times, it was the
worst of times, it was the age of wisdom, it was the age of foolishness, it was
the epoch of belief, it was the epoch of incredulity, it was the season of
Light, it was the season of Darkness, it was the spring of hope, it was the
winter of despair, we had everything before us, we were all going to Heaven, we
were all going direct the other way----in short, the period was so far like the
present period that some of its noisiest authorities insisted upon its being
received, for good or for evil, in the superlative degree of comparison only."
Charles Dickens
The words Dickens wrote 161 years ago resonate eerily
with where we are today. For some people,
it is indeed the best of times. For far
too many others, however, it is among the most difficult of times.
Amid the overwhelming flow of each day's news, we learn
about the movements of the stock market, which until recently appeared to be on
a fast track to the ionosphere. Recent pullbacks,
though, suggest that it is time for a reality check.
The market that the media usually refers to is either
the Dow Jones Industrial Average or the Standard & Poor's 500 Index. The Dow consists of 30 well-known stocks that
used to be called blue chips. The S&P, by
contrast, is far broader, including huge companies as well as tiny companies.
Although the S&P appears to provide a more representative
view, it does not. Why? Because the
S&P is weighted heavily toward the tech companies with the greatest market
valuations. These are often referred to as
the FAANGs: Facebook, Amazon, Apple, Netflix, and Google.
For the year to date, the average gain for these five
stocks is 51.7%. If, however, we view the
S&P Index on an equal-weighted basis, the year-to-date result turns out to
be a loss of 10.6%. That still includes
the FAANGs. Excluding those companies,
the numbers are even worse, which is why many investors are still wondering why
their portfolios are down even though the news media seems to indicate
otherwise.
Are these great companies? They are, but there are important issues to ponder. In all cases, as companies grow, their
potential for further growth diminishes.
Companies such as Amazon and Netflix have had extraordinary gains due to
the pandemic, but there will come a time when folks are out and about again, not
living online.
A decade and a half ago, Apple was at best an also-ran. Then came the iPhone, which along with
Samsung has largely saturated the world with handheld devices. There may be more to come, but at a moderating
pace.
Facebook, too, has been a major beneficiary of the
current constraints, replacing actual social contact with digital contact,
which may be better than nothing, but not quite as satisfying.
From the perspective of fundamental analysis, these are
all richly valued companies, ranging from 34 times earnings to 121 times
earnings. That compares with traditional
market valuations of 15 to 18 times.
When stock valuations are high, one or more of the following
factors are needed to support them: an above average rate of future growth, consistent
past growth, and low interest rates. A hesitation
in growth, even for a short time, can undermine a stock's price.
Chasing them may not be a good idea.
N. Russell Wayne, CFP®
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