COVID-19 UPDATE: S&P 500 Mega-caps not a "bubble" as Top 5 earnings share = top 5 market cap share. San Diego CFA poll shows CFA holders bearish.

Thursday was a rough day in the markets, with a fierce sell-off and S&P 500 down >1%.  The carnage was in the mega-caps and there is a growing chorus that the S&P 500 is distorted by the outsized market cap of the Big 5 tech names.  We have seen multiple citations of the “craziness” of this market as the top 5 are now 22% weight of the S&P 500.  We discuss this at length below, but we just don’t see the bubble. The top 5 stocks (AAPL, MSFT, AMZN, FB, GOOG) are 18% of earnings and like >80% of 2020 EPS growth.  So, their 22% market cap share does not seem so out of line with their nearly 20% net income share.  After all, aren’t these franchise cos?

It looks like this is the week that definitely saw US case surge finally plateau (and hopefully turn into a decline this weekend).  It looks like all the mitigation measures taken in the past few weeks are working.  And the White House is now endorsing mask use.  Thus, we see the economy risks diminishing. 

And as we have commented in the past, as the national disease panic fades, local behavior recovers.  In fact, our survey of San Diego CFA members conducted this evening (see the last bullet) shows how CFA members’ perception of national trends governs their own personal decisions. 

This is why we are not too alarmed at seeing economic data stall in the past week.  Virus spread started accelerating in early June and the media and skeptics and policymakers have been quite alarmed — appropriately, actually.  But this had the effect of dampening economic momentum.  If cases are now peaking, economic momentum will resume.  And our policy strategist, Tom Block, expects a stimulus package passed and signed by early August.

Thus, the set up for stocks, in our view, is extremely attractive right now:

– disease is plateauing (again)
– economic momentum should recover
– fiscal stimulus coming
– sentiment remains very negative (see San Diego CFA survey below)
– $5T cash on sidelines

And many are ringing the bell (top of market).



STRATEGY: The Top 5 stocks earnings share = market cap share.  Not a “bubble”
5 sentences on the reminisces of the 1999 dot-com bubble, my early career experience…
I was a wireless analyst in 1999, working at Salomon Brothers, which at that time, was the “firm” for wireless and telecom IPOs and investment banking.  We had Jack Grubman running the Telecom group and he was a giant among short-statured telecom research franchises.  So, suffice it to say, I was a ground zero witness to that dot-com bubble.  The dot-com bubble fueled a “get rich quick” mentality as tech IPOs saw tremendous gains, any renaming to “internet” caused a surge and investors were funding and throwing money at any new telecom/internet idea.  I don’t have enough space in this daily commentary to describe the mania that was prevalent then, but one of the realities is this environment created a mismatching of pricing because:

– Companies that raised money in IPOs use that money to invest/fund/buy products from other start-up –> pyramid-like
– Venture funds were returning 100X-500X, so new funds were funded with massive profits from legacy funds –>  pyramid-like
– Internet was growing so fast, but capital requirements so high, companies that were growing were losing tons of $$$ –> shift away from EPS

Bottom line – equity prices rose faster (straight up) than earnings (straight down).  So, there was a growing and visible disconnect between asset prices and EPS.  This was the bubble.  If these dot-com companies were highly profitable, nobody would have called it a bubble.

Fast forward –> 2020.  Those seeing “echoes of 1999”
Over the past few weeks, there has been a growing chorus of investors calling this equity market ultra concentrated, pointing to the outsized gains of the top 5 largest stocks in the S&P 500.  In fact, even this morning, there were a few clients who shared with me this email from a broker.  The message is all the same:

– the S&P 500 market is “unhealthy” because the top 5 stocks are too big
– many even point to this mirroring the 1999 “dot-com” bubble

Source: sell-side broker AM note


Top 5 “Market Cap share” about the same as “Earnings share”
Below is a comparison of the market cap of the top 5 largest stocks in the S&P 500 (AAPL, MSFT, AMZN, FB, GOOGL) and their corresponding earnings share:

– Market cap share is 22%
– EPS share is 18%
So, one can see the valuation of the top 5 is not necessarily distorted.

Source: Fundstrat

This is actually true for the top 10 largest stocks in the S&P 500 as well.  The earnings share is grey and the market cap share is blue.  With the exception of Amazon.com, the relative proportions are not that far off.

Source: Fundstrat

And stepping back, below is the earnings share vs market cap share of each constituent in the S&P 500.  The x-axis is net income share and y-axis is market cap share.  Any significant deviation above the trendline is an outlier.  As indicated, only Amazon.com is an outlier.

– One can argue these top 5 companies have higher revenue and EPS growth, and thus, deserve to have a higher valuation.
– And their market positions are considerably more dominant, which warrants a smaller equity risk premia (higher PE) as their incremental profitabilIty should be higher.

Source: Fundstrat


Top 5 stocks have superior EPS growth = higher P/E
Take a look at both the 3-yr EPS CAGR (2016-2019) and 2020 EPS growth.  The Top 5 are all growing far faster than the S&P 500 overall.  Thus, if one believes higher EPS growth warrants a P/E premium, this is what we see today.

– more importantly, we hardly see the S&P 500 price distorted by the influence of the top 5.

Source: Fundstrat 



US Top 5 stocks share at 22% is about in line with the Rest of the World…
Moreover, 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.  

– Korea, China and Japan top 1% largest stocks are massively higher market cap share
– While this is not necessarily true in UK and Europe to the same extent, the top 1% of companies are 12X-13X larger in market cap.

Source: Fundstrat  


Earnings share = market cap share for RoW just like USA 
The earnings share and market cap share show the same relationship.  It is essentially the same.

Source: Fundstrat  


But 2021 EPS growth is primarily driven by Epicenter stocks = OW Epicenter…
We are not saying that secular growth/FANG/bond proxies are going to continue to outperform.  Rather, we are saying the S&P 500 is not necessarily “irrationally priced” which many top-callers might assert.  Moreover, look at EPS growth contributors in 2021, based on consensus forecasts.

– the epicenter, Industrials, Discretionary, Financials and Energy, will account for 62% of EPS growth
– 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.

And cyclically sensitive are the epicenter groups.  And as shown below, this is a lot of market cap rotation from 72% of the market to 28%.  Thus, should it be any surprise if these stocks see a massive surge?

Below is our Granny Shots list.  This is a hybrid core/epicenter/thematic list.  

POINT #1: More and more likely cases “peaking” — 4 days cases flat week over week… 
Total USA cases came in at 70,593 which is flat with the case figures a week ago (see the second chart) 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 7D past the all-time high of 76,737seen on 7/17.

Source: COVID-19 Tracking Project

Increasingly, the chart below is becoming way more useful.   This is looking at the daily cases vs same-day 7D ago. This smooths out seasonality and is a crude proxy for R0 value.  If the 7D is flat to negative, the disease is slowing.  

– Notice for the past 4 days, the 7D delta in cases is flat
– this is a huge contrast to the surge seen in the past 3-4 weeks and looks more like the situation in early June.

Source: COVID-19 Tracking Project


6 states saw large 1D increases
Georgia         4,286 vs 3,314 (1D) +972
Alabama        2,399 vs 1,455         +944
Iowa                  841 vs    319        +522
Florida        10,249 vs   9,785        +464
Arkansas       1,013 vs      591       +422
Arizona          2,335 vs 1,926        +409
Total 6 states                               +3,733

6 states saw large 1D declines
California    12,040 vs 12,807 (1D) -767
Mississippi       982 vs   1,547         -565
Louisiana       2,296 vs 2,771         -475
Texas             9,507 vs 9,879         -372
Oklahoma         668 vs   975          -307
North Carolina 1,892 vs 2,140        -248
Total 6 states                                -2,734

Source: COVID-19 Tracking Project


POINT #2: F-CAT cases almost certainly peaked in FL, AZ and TX and waiting for CA
The trends in F-CAT are quite positive as well.  This has been the case for the entire week and as we finish this week, it looks like this remains the case:

– FL, cases peaked last week
– CA, cases still high but looking definitely peaked in Los Angeles
– AZ, cases peaked 3 weeks ago
– TX cases peaked last week

Source: COVID-19 Tracking Project


And in total, F-CAT remains about half of US cases and as shown, it has been 7 days since the record 40,278 reported.  More importantly:
– F-CAT cases have been down vs 7D ago in each of the last 3 days
– if F-CAT has peaked, along with NY tristate and VIMMP, 60% of the US is past wave 1.
– many other states like GA and SC are experiencing a contemporaneous surge, not any renewed wave

Thus, if F-CAT is peaking, the case growth in the US is largely peaked.

Source: COVID-19 Tracking Project


The “nucleus” cities are still not showing a re-acceleration of cases = confirming peak
The good news is the 4 nucleus cities are not showing a resurgence in case growth.  While CA case counts remain elevated, it appears to be taking place outside of Los Angeles but still within SoCal.

– LA daily cases are flat and not nearly the levels implied by CA state reflecting 12,000 cases per day.

Source: Johns Hopkins


Texas: Dallas + San Antonio + Austin are nearing NYC level of prevalence… Houston + Plano slowing…
Below is the updated “rebased” cumulative cases per 1mm residents for Texas.  We have plotted NYC for reference as well.  As many of our clients know, Houston was the original center point for the post-June explosion of cases in TX (which we believe largely stems from Houston being the first focal point for BLM protests).  But take a look at the prevalence curves now:

– in the past few weeks, Dallas, San Antonio and Austin have soared past Houston.
– at this pace, these 3 cities will soon match NYC for COVID-19 prevalence

If this plays out in this manner, it does lend credence to the notion that COVID-19 sees a level of uncontained spread.  And then suddenly, hits a break point and the infection rate slows.

Source: Johns Hopkins


POINT #3: San Diego CFA Poll confirms investors bearish and waiting for vaccine…
I presented to the San Diego CFA Society this past evening.  It was a remote event, unfortunately, as I would have gladly done this while on the West Coast.  The New Mexico CFA Society members also joined.  The hosts of the event were gracious enough to let me conduct a poll of the participants of the event.  I asked 5 questions and the results are below, along with my annotations.

– CFA members are bearish/neutral, with only 44% seeing >10% upside in stocks
– 59% think Growth outperforms over next 12M –> not a surprise, but it shows how consensus this view is
– 50% say the most important market driver is the disease vs 47% saying Fed.
– 47% see a vaccine in next 12M –> how could they be bearish if they see a vaccine?


Only 44% see a 10% upside to stocks in the next 12M.  This is another survey upon other surveys that highlight how cautious investors are about markets.

Source: San Diego CFA Society Poll conducted 7/23/2020


This is interesting as disease is seen as more important than the Fed.  I suspect if we see a decisive breakdown in cases, this would certainly support seeing investor sentiment turn bullish.

Source: San Diego CFA Society Poll conducted 7/23/2020


Everybody loves Growth at 59% and 22% love Defensives.  
– So only 22% like Cyclicals.  If a cure is discovered, I am sure this ratio flips 180 degrees.

Source: San Diego CFA Society Poll conducted 7/23/2020


And the plurality sees a cure/vaccine in 12M.  So, there is inherent optimism on a healthcare solution.  Again, I think if this happens, sentiment flips big time = stocks go up.

Source: San Diego CFA Society Poll conducted 7/23/2020


Lastly, I asked about willingness to get on a plane.  Here it shows 41% will not get on a plane until there is a vaccine.  So, you can see personal preference is governing market positioning.  Again, upside.  Because if we see a cure = flip in sentiment. 

Source: San Diego CFA Society Poll conducted 7/23/2020




RANDOM: Baseball Opening Day is here… NBA end of month…
Live professional league sports is back, with the MLB (baseball) opening day today and the NBA (basketball) at the end of July.  This is a big deal.  The cancellation of the NBA season, back in midst of pandemic, was probably the surest sign of how much pain lay ahead for the US.

And the return of sports is important on so many levels.  MLB and NBA are distinctly American sports and so central to how Americans socialize, mark seasons and build friendships and entertainment.

The MLB Thursday games are:

Yankees at Nationals
Giants at Dodgers

So it is both Coasts seeing their teams play.

https://twitter.com/mlb/status/1286149056088211459?s=12

https://twitter.com/nba/status/1285743331150979072?s=21