Thursday, July 13, 2023
There are eight stocks that have put together a phenomenal start to the year and fortunately, seven out of eight of these stocks are in the top 10 holdings of our Schwab Total Stock Market index as well as the S&P 500 indexes we hold. The eighth stock, Netflix, is in the same index, but not in the top ten. Anyway, these eight stocks account for 30% of the S&P 500’s market capitalization. If you exclude the “Megacap-8” as analyst Ed Yardeni likes to call them from the S&P 500, this benchmark index is floundering through June 30 while if you include them the S&P 500 is up 16.89%. Isn’t it nice to have our index funds market-cap weighted with the largest companies holding the biggest weightings in the index?
The Megacap-8 include: Alphabet, Amazon, Apple, Netflix, Meta (formerly called Facebook), Microsoft, Nvidia and Tesla. Nvidia is up 190% in the first half of the year due to blow-out earnings numbers that were reported a few weeks ago. As Morningstar states, Nvidia’s GPU computer chips collect large swaths of data, runs the data through algorithms which in turn helps to produce conclusions in the same way as humans. “Today’s basic variants of AI are consumer-oriented and include digital assistants, image recognition, natural language processing and recommendation engines.” Nvidia’s GPUs have been selling like hotcakes. Other companies like Microsoft, Google and Tesla among others will also help push the boundaries of what AI can and will do for us. This is why I like investing in the stock market index – you just never know what the next investment field is going to be. Let’s just hope these new technologies are developed safely and for all of our benefit.
Will these stocks continue this performance in the second half of the year? One measuring stick investors use is the forward price-to-earnings ratio. Essentially, a forward P/E ratio is the number of years it would take at next year’s estimated earnings to pay for the current price of the underlying stock(s). The average forward P/E for the S&P 500 is 15 and the current forward P/E is 19.1. The Megacap-8 stocks mentioned above currently have a forward P/E of 30.4; thus, all things being equal, it would take 30.4 years of next year’s estimated earnings to pay for the current price of the Megacap-8 (this is not taking into account the rise and fall of the market nor the increase or decrease in earnings beyond this next year). If you exclude those eight stocks, the remaining 492 stocks have a 16.4 forward P/E – much closer to the average. The moral of the story is that I don’t know if putting all of your chips on those eight companies makes the most sense from a valuation standpoint at the present time. I believe most investors are hoping the Megacap-8 level off and the rest of the S&P 500 catches up, but that all depends upon the denominator or this next 12-18 months’ worth of earnings. If we end up entering a recession, earnings will most likely decline unless a decline is baked into the forward corporate guidance. A decline in earnings will inflate the forward P/E ratios even more.
Due to this uncertainty, I am quite comfortable continuing with our current model, which has some defensive oriented securities in it. We continue to hold funds like Berkshire Hathaway, Vanguard Dividend Growth, Primecap Odyssey Growth, First Eagle Overseas and Dodge & Cox International that are lagging now but will not go down as much should the market drop due to an impending recession. If we do not end up in a recession, I believe we could see some areas that did not do as well over the past few years pick up the pace. For example, the S&P 600 small-cap index currently has a P/E of 13.3 – much cheaper than the S&P 500 large-cap index. As mentioned above, I believe there is also a possibility that the 492 stocks that have not participated in this rally could have their day in the sun. We will see. In the meantime, let’s hope inflation continues its downward descent and that, in turn, helps our bond funds – and equity holdings – find their footing.
If you have not stopped in to see us lately, please do not hesitate to contact me to schedule an appointment. Enclosed you will find your Portfolio Holdings, Performance Analysis and Position Performance reports as of June 30, and a quarterly Account Management Fee Statement. Please call us should you desire the most recent copy of our Form ADV Part 2A. In addition, do not forget to notify us should your investment objectives or personal financial situation change.
Enjoy the summer!!