Well, we did it. We created an equity bubble during a global depression brought on by an existential brush with a literal viral apocalypse.
The furious run in US equities since the March panic nadir has the S&P trading on a 24 multiple, which means this is the third-most expensive market in 120 years.
“The S&P’s trailing PE currently [at] 24x was surpassed only in December 1921 and June of 1999”, BofA’s Michael Hartnett wrote, in the latest edition of his popular weekly “Flow Show” series.
That’s quite the accomplishment and speaks to a number of things, not least of which is the Fed’s power to levitate financial asset prices.
But it also speaks to the fact that, at the index level, the S&P is becoming increasingly synonymous with just five names. Indeed, on some days, Apple makes or breaks the entire US market.
So, while it’s tempting to suggest that what you see in the visual above is “insane” (or fill in your favorite derisive adjective), it’s predicated in part on the inexorable ascent of companies which benefit disproportionately from the social and economic conditions brought about by the pandemic.
In other words, while there is indeed something inherently absurd about the notion of record-high stock prices in the face of a global public health crisis and the worst economic downturn in a century, the rally is almost entirely attributable to outperformance from businesses whose continued dominance is now virtually assured.
The economic and social trends favoring big US tech companies were already entrenched prior to the pandemic. What’s different now is that many of the products and services those companies sell and provide are wholly indispensable. Look at what companies run on AWS, for example — then imagine a post-pandemic world without those companies.
Of course, this means that, increasingly, the concept of “corporate America” has no meaning outside of FAAMG. Underscoring that is another chart from BofA’s Hartnett (left, below).
“The S&P 500 is the most negatively correlated to the S&P 500 equal weighted index since 2017, 2000, and 1999”, Hartnett wrote, before updating a visual he’s used quite often recently. The right pane (above) shows that if the S&P was just the tech sector, it would be trading at 4,322.
On the other hand, if it were just banks and energy, we’d be in rough shape.
If businesses fail and job losses continue there are less customers for web services, less advertising, less cap spending, less buying of phones, hardware, etc. ultimately they do need a healthy economy with innovation and competition.
The problem with relying on the economy to create an “emperor has no clothes” moment is the knowledge that the market leads the economy as well as the religious faith embedded in the idea that the Fed is supplying the downside put. It seems obvious it adds fragility and one day it will end in disaster this judgment appears of little value on August 29th, 2020.