Welcome to the weekly market update from Signature Wealth Management. I’m Brian Ransom, Research Director from Signature Wealth and here’s what happened in the market this week.
The S&P 500 continues to slide and is now down 5.4% from all-time highs. Currently, the stock market continues to battle through inflation scares and rising interest rates as volatility picks up.
In the news this week, China has cut it’s equivalent of the Fed Funds rate to help add liquidity to a slowing economy. Existing-home sales here in the US hit a 15 year high in 2021. Since a “correction” is defined as a downturn in an index of 10% or more, the Nasdaq is now in correction territory as of the 19th.
With the technology and growth-heavy Nasdaq index entering into correction territory following three years of +25% annual returns, industry analysts are prognosticating that many technology and growth stocks were actually in a bubble and that bubble may have just popped. In today’s update, I’ll examine some of the intricacies revolving around the growth indexes and the stocks driving some of the bubble chatter.
The quintessential stock market bubble is the Dotcom bubble that formed in the late 90’s. During that time, returns in the S&P 500 were dominated by the largest holdings in the index with elevated valuations. We’re seeing a similar dynamic today with the top 10 stocks in the index making up 31% of the market capitalization of the S&P 500, a level not seen since the year 2000. Likewise, those top 10 stocks are very elevated in price at a similar level as the Dotcom bubble. Bears would argue that a concentration in stocks with elevated valuations would be an indicator of a bubble.
However, elevated valuations alone do not constitute a bubble. When those valuations become disconnected from earnings, that prompts the official formation and subsequent popping of a bubble. While the top 6 holdings in the S&P 500 leading up to the Dotcom saw significant growth in earnings, beginning in 2001 those earnings fell by nearly 24%. The significant drop in earnings is ultimately what sparked the significant drop in stock price and the subsequent collapse in the growth indices.
Therefore, if this is indeed another growth stock bubble, then we should see a similar significant drop in earnings from the top holdings in the index that changes the long-term growth trajectory of those companies with elevated valuations. That drop in earnings, as of January of 2022, has not happened. And investors should ask themselves whether or not that makes sense based on the business fundamentals and financial analysis.
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1.FactSet Research Systems. (n.d.). S&P 500 (Interactive Charts). Retrieved January 20, 2022, from FactSet Database.
2.J.P. Morgan Asset Management. “Guide to the Markets.” 1Q 2022, as of December 31, 2021. Retrieved from https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/,
3.FactSet Research Systems. (n.d.). Company/Security Financials. Retrieved January 20, 2022, from FactSet Database.
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