What will it take to get U.S. equities up on the year?
Originally posted on The Convergex Blog.
Summary: Even with today’s “Forget the Fed” rally, the S&P 500 is still down 3.9% year to date. With 75 trading days left in 2015, we’re hearing one question more and more: “What will it take to get U.S. equities up on the year?” Today we answer that question by disassembling the index into sectors and “heavyweight” stocks. For example, just getting the Financials sector back to flat (it is currently down 5.4% YTD) wouldn’t do it. At a 17% weighting in the S&P 500, that would only be 0.9% incremental performance. Even if Financials end the year up 10%, that would only add another 1.7%. Still in the red, so we’ll need to look elsewhere. Energy, down 19.8% YTD, is a logical place to hope for a bounce, but even if that sector rallied all the way back to flat for 2015 in one day, its current 7% weighting would only go to 9%, and still leave the index down on the year. The one sector that can make the difference is technology, which at a 20% weight in the S&P 500 can most easily push us back into black for the year. Tech is currently down 1.1%; get the group to +10% on the year (adding 2 percentage points for the index) AND get Financials up 10%, and you’re basically back to flat. Yes, some combination of many sectors pulling the load will help, but some group has to lead.
Pop quiz time. You probably know that the S&P 500 is up 5.9% since the August 25 lows, but do know which sectors really pulled their weight to get the market out of that seeming death spiral last month? Turns out there are just four:
Technology, up 8.4%
Energy, up 7.3%
Consumer Discretionary, up 6.8%
Industrials, up 6.5%
By comparison, Utilities are actually lower by 0.4% from the late August market lows, and four sectors (Financials, Consumer Staples, Materials and Telecomm) are all up less than 5%. Health care is up 5.1% since then.
Next Question: How many of the top 11 individual names by weighting in the S&P 500 have outperformed since those same August 25th lows? You know the ones we’re talking about… Apple, with a 4% weight (more than all the Utility companies in the S&P 500), is an important stock in the index, but so is the combined GOOG/GOOGL (2.1% of the S&P) and Microsoft (2.0% weight). The answer:
Eight of the top 11 names (in total almost 20% of the entire index by market cap) have actually outperformed the S&P 500 since the August 25 lows.
The list: Apple (up 12.1%), Google (up 9.1%), Microsoft (up 8.7%), ExxonMobil (up 6.6%), GE (up 8.7%), Well Fargo (up 6.9%), JP Morgan (up 6.9%), and Amazon (up 12.0%)
Pfizer performed roughly in line (up 5.8%)
Only two names have underperformed from late August to today’s close: Johnson & Johnson (up 4.0%) and Berkshire Hathaway (up 2.6%)
Why 11, and not 10 names? Google’s dual classes of stocks makes any “Top 10” S&P name list problematic, since if the company had one class it would be in the Top 10. In its current manifestation, you need to add both together.
So, final question: is the rally from the lows a function of money flows into growth names (tech and consumer) and a bounce in oversold groups (energy and industrials)? Or is it just a mega-cap biased asset allocation trade into U.S. stocks? This reminds me of the old “The Holy Roman Empire was not holy, nor Roman, nor an empire. Discuss.” (In case you’ve forgotten, it was German, limited in ethnographic makeup, and remarkably corrupt.)
Nonetheless, this parlor game/trivia contest has a purpose: its structure is useful in solving the puzzle called “Can the U.S. stock market get back to flat on the year?” With the S&P 500 down some 3.9% as of the close today and just 75 days until the New Year, time is not exactly on the market’s side. Throw in the typical seasonal fireworks around October, a still volatile crude oil market, and the uncertainties over the Chinese economy, and you’ve got the makings for a spicy end to 2015. Oh, and someone said the Fed was meeting on Thursday. That might be important as well.
While there might be 502 equities in the S&P 500 (don’t ask…), and 10 major industry sectors, like in Animal Farm “Some are more equal than others”. For example, three sectors comprise half the index: Technology (20%), Financials (17%) and Health Care (15%). The ten stocks by market cap comprise 17% of the index, and lump in the two classes of Google stock and you get over 19% of the S&P 500 tied to the fortunes of just 2.2% of the companies in the S&P.
So let’s go shopping through the Index and come up with “Back to flat for 2015”. Here are three ways to get there:
Technology is down 1.1% for the year to date, and at 20% of the S&P 500 by market cap/weight, it’s the logical place to start. To erase the market’s 3.9% decline, while leaving everything else unchanged, would require the tech sector to rally 20% (3.9/0.20).
Financials are the second most important group, so let’s try there. The sector is down 5.4% year to date, despite being a theoretically great way to play a steepening yield curve as bond markets factor in a Fed rate cycle. At a 17% weighting, the group would need to rally 23% from here if it were to pull the S&P into positive territory for the year.
How about the beleaguered Energy sector? Down almost 20% (19.8%, to be exact), it could rally all the way back to unchanged on the year and the S&P would still be down. That’s because at a 7% weight (which would go to 9% with that kind of rally), a 25% move would only move the Index 2.3% higher.
Now, obviously no one sector will be the market’s savior, so we’ll need a mix of industry performance to lift U.S. equities into the black once again. We saw such a combo platter of results from the August 25th lows we described earlier. Some final thoughts:
It is hard to put together where U.S. stocks go green on the year that doesn’t include Technology and/or Financials. The former is going to need some confidence about economic growth in 2016 (both consumer and business spending), and the latter needs that plus a steepening yield curve. Remember: these two groups are 37% of the index.
Energy stocks may provide some leadership in a rally led by stabilizing crude oil prices, but theirs is more a sideline cheering role than a player on the field. At just a 7% weight, the group is too small to do any serious lifting and two names – ExxonMobil and Chevron – are 2.5% of the S&P 500 on their own.
In summary, while an S&P 500 that is down 3.9% may seem like an easy reach back to unchanged and then up on the year, in reality it’s not that simple. We’ll need to see real confidence in tech spending for next year AND general consumer trends AND a steeper yield curve to move the needle on enough of the Index to really turn things around.
Closing out on a more positive note about those “Top 11” S&P 500 names we mentioned… Their average one year forward P/E is just 14.5x, and their average dividend yield is 2.2%. Those kinds of statistics explain why they led the bounce from late August. Whether they can propel the top of the index list from here remains to be seen. Read more and sign-up for our daily email here.













