It was a rough week with S&P 500 down 0.3% and with the carnage in the mega-caps. There’s a growing chorus the S&P 500 is significantly distorted by the outsized market cap of the Big 5 tech names (AAPL, MSFT, AMZN, FB, GOOG), now a 22% weight in the index. I don’t see the bubble. The top 5 are 18% of earnings and >80% of 2020 EPS growth. So, that 22% market cap share does not seem so out of line with their nearly 20% net income share. After all, aren’t these franchise companies? (More below.)

It looks like this is the week that saw US case surge finally plateau (and hopefully turn into a decline this weekend). And the White House is now endorsing mask use. Thus, we see the economy risks diminishing. And as I have noted in the past, as the national disease panic fades, local behavior recovers.

S&P 500 Mega-Caps Not in a ‘Bubble’; Big EPS = Big Mkt Cap

This is why I am not too shocked at seeing economic data stall in the past week. Virus spread reaccelerated in early June and the media and skeptics and policymakers have been quite alarmed — appropriately. But this dampened economic momentum. If cases are peaking, economic momentum will resume. Our policy strategist, Tom Block, expects a stimulus package passed and signed by early August.

The set up for stocks, in our view, is attractive right now, with the disease plateauing (again), economic momentum should recover; fiscal stimulus coming; sentiment still negative (see San Diego CFA survey below); and $5 trillion cash on sidelines. Yet many are ringing the bell (top of market).

STRATEGY: Not a “bubble.” As a Salmon Bros. wireless analyst in 1999, I had a ringside seat at the dot-com bubble implosion. There’s not enough space here to describe the mania prevalent then. Effectively, the dot-com stocks that soared had no profits nor expectations of such. Had they been profitable, nobody would have called it a bubble. Equity prices rose faster (straight up) than earnings (straight down). There was a growing and visible disconnect between asset prices and EPS.

Fast forward to 2020. Over the past few weeks, there has been a growing chorus of investors saying this equity market is ultra-concentrated, mirroring 1999, and that the S&P 500 market is “unhealthy” because the top 5 stocks are too big. Yet, the market cap of the top 5 in the S&P 500 (AAPL, MSFT, AMZN, FB, GOOGL), 22%, generally corresponds with their EPS share, 18%. Also, one can argue these top 5 have higher revenue and EPS growth, with considerably more dominant market positions, which warrants a smaller equity risk premia (higher PE). Thus, one can see the valuation is not necessarily distorted.

S&P 500 Mega-Caps Not in a ‘Bubble’; Big EPS = Big Mkt Cap

Moreover, their position is about in line with stock markets in the rest of the world. For example, and the high market cap share of the top 1% largest companies in an index should be disproportionately high. Take a look at the S&P 500 compared to 5 major global stock indices. (See nearby chart.) Earnings share = market cap share for the rest of the world, just like the US.

That said, please note, as I’ve pointed out for months, that 2021 EPS growth is primarily driven by Epicenter stocks = OW Epicenter…. I’m not saying that secular growth/FANG/bond proxies are going to continue to outperform. Look at EPS growth contributors in 2021, based on consensus forecasts. (See nearby chart.)

The epicenter, Industrials, Discretionary, Financials and Energy, will account for 62% of EPS growth, but they are only 26% of market cap today. And going back to our prior observation, if the virus is weakening (our view), we want to OW cyclically sensitive. This is a lot of potential market cap rotation from 72% of the market to 28%.

POINT #1: More and more likely US cases “peaking” — 4 days cases flat week over week. Total USA cases came in at 70,593 Thursday, which is flat with the case figures a week ago and this is looking more and more likely that USA cases have plateaued. The case figures for Friday (7/24) will be the decider as that is 7 days past the all-time high of 76,737 seen on 7/17.

POINT #2: Cases have almost certainly peaked in FL, AZ and TX. Waiting for CA. (F-CAT). The trends in F-CAT, about half US cases, are quite positive as well. It has been 7 days since the record 40,278 reported. More importantly, F-CAT cases have been down vs 7 days ago in each of the last 3 days. So if F-CAT has peaked, along with NY tristate, and some other large states, then about 60% of the US is past wave 1.

POINT #3: In a presentation I gave to the San Diego CFA Society Thursday, I asked 5 questions and the interesting results follow, along with my annotations. First, CFA members are bearish/neutral, with only 44% seeing >10% upside in stocks, and 59% think growth outperforms over next 12 months. That’s not a surprise, but it shows how consensus this view is. Second, 50% say the most important market driver is the disease vs 47% saying the Fed. But if 47% see a vaccine in next 12 months, how could they be bearish? Everybody loves growth at 59% and 22% love defensives.

Only 22% like Cyclicals. If a cure is discovered, I think this ratio flips 180 degrees. And the plurality sees a cure/vaccine in 12 months. So, there is inherent optimism on a healthcare solution. Again, I think if this happens, sentiment flips big time = stocks go up. Lastly, I asked about willingness to get on a plane. Here 41% of those surveyed will not get on a plane until there is a vaccine. You can see personal preference is governing market positioning. Again, upside. Because if we see a cure = flip in sentiment.

Essentially, this is one more survey that highlights how cautious investors are. Interestingly, the disease is seen as more important than the Fed. I suspect if we see a decisive breakdown in cases, this would certainly support sentiment turning bullish.

Figure: Comparative matrix of risk/reward drivers in 2020
Per FS Insight

S&P 500 Mega-Caps Not in a ‘Bubble’; Big EPS = Big Mkt Cap

Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 50
** Performance is calculated since strategy introduction, 1/10/2019

S&P 500 Mega-Caps Not in a ‘Bubble’; Big EPS = Big Mkt Cap
Source: FS Insight, FactSet
* Portfolio strategy introduced in December ’19 rebalance, replacing 2019 portfolio recommendation – “FANG in odd years”

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