Well it’s Friday, and that means Goldman is ready to tell you about the “conversations” they’ve been having with clients.
That’s always amusing because these would be the same clients who at least one former employee famously claimed are known internally as “muppets.”
This week the muppets were apparently asking about the Nasdaq. More specifically, Bert and Ernie want to know whether it will continue to outperform the S&P.
“If you ain’t up on things” (to use a rap colloquialism), the Nasdaq 100 has returned 32% during the past 12 months vs. 19% for the S&P. Obviously, it helps when AAPL, GOOGL, AMZN, and FB are more heavily weighted.
Whatever, right? You don’t care. You’ve already tuned out for the week. It’s 5:30 on the east coast.
But for those who are still inclined to think a little, here’s what Goldman says their clients are asking or, put differently, “quoth muppets, quoth Goldman”…
Results so far suggest that S&P 500 EPS grew by 13% in 1Q, the fastest year/year pace of growth since 3Q 2011. 82% of S&P 500 companies have reported earnings and 50% of firms have beat consensus EPS expectations, above the long-term average of 46%. Health Care, Industrials and Info Tech companies have reported the most positive earnings surprises of any sector. 41% of S&P 500 companies have also surpassed consensus sales estimates, the most positive ratio of surprises in nearly six years (2Q 2011; Exhibit 5).
Better-than-expected Info Tech earnings have supported the recent rally in the technology-heavy Nasdaq 100 (NDX). NDX, 100 of the largest stocks in the composite index, reached an all-time high today (5646), along with the S&P 500 (2399). Information Technology is the best performing sector YTD in both absolute and risk-adjusted terms and has led both indices. Technology accounts for 58% of NDX versus 23% of the S&P 500 and largely explains the 870 bp YTD outperformance (16% vs. 7%; see Exhibit 1).
NDX is even more concentrated at the stock-level, with the five largest stocks comprising 42% of the index compared with 13% of S&P 500. Apple (AAPL) alone accounts for 12% of NDX versus 4% of the S&P 500. The index weight of AAPL and its stellar performance explains roughly 25% of the 79 pp excess return of NDX vs. S&P 500 since 2009 (229% vs. 150%). Alphabet (GOOGL), Microsoft (MSFT), Amazon (AMZN), and Facebook (FB) are the next four largest stocks in both indices (Exhibit 2). Each of the five stocks has beaten the S&P 500 YTD, by an average of 16 pp, and together have contributed 56% of NDX and 33% of S&P 500 returns YTD.
Investors ask whether NDX outperformance will continue. Current relative valuation may restrain upside, but superior sales and EPS growth prospects coupled with a larger weight in Technology suggests NDX total return of +2% vs. -1% for S&P 500 in the next 12 months. Excess return of 300 bp would rank in the 41st percentile since 2002.
The relative valuation of NDX vs. S&P 500 is in line with the 10-year average and will curb the magnitude of further outperformance. The valuation of NDX vs. S&P 500 using EV/Sales is most predictive of future relative returns. Current relative EV/Sales is 0.4 standard deviations below the 10-year average (Exhibit 3). A return to this average would suggest 3 pp of outperformance. In contrast, NDX vs. S&P 500 trades 0.8 standard deviations expensive on an EV/EBITDA basis and 0.1 standard deviations expensive using forward P/E. Taken together, the current relative valuation of NDX versus the S&P 500 appears consistent with the past 10 years.
The performance of NDX vs. S&P 500 is dependent on economic growth, but exhibits low sensitivity to other macro variables. NDX vs. S&P 500 returns show low correlation with changes in inflation, interest rates, USD, and oil. However, NDX is heavily concentrated in growth equities and NDX vs. S&P 500 relative returns are positively correlated with our growth factor (see Exhibit 4). Our US Economics team expects 2017 US GDP growth of 2.1%. Our US MAP score, a measure of economic data surprises, is in positive territory. Growth stocks typically outperform in this type of economic environment. Seven of the 25 largest NDX firms (GOOGL, AMZN, FB, ADBE, NFLX, PYPL, and CELG) meet our secular growth criteria. However, a reacceleration or collapse in economic growth would pose a risk to further NDX outperformance.
The micro landscape favors NDX versus S&P 500. Looking into 2018, consensus forecasts faster revenue and EPS growth for NDX versus S&P 500. Superior sales growth (8.4% vs. 5.3%) and earnings growth (13.5% vs. 9.7%) represent key drivers for further NDX outperformance. Since the start of the earnings season, revisions to consensus estimates have been more positive for NDX than for S&P 500. Long-term NDX earnings growth prospects are strong relative to S&P 500 (19% vs. 12%). However, while the 2018 estimates favor NDX, 2017 estimates are mixed. NDX sales in 2017 are forecast to grow by 8.3% vs. 7.5% for the overall S&P 500 (5.3% excluding Energy), the smallest gap since 2008. Similarly, NDX earnings are expected to rise by 9.0% in 2017, versus 10.7% for the S&P 500 (7.7% ex-Energy).