Markets gains may slow as the reopening economy peaks.
by Jurrien Timmer, Director, Global Macro, Fidelity Investments
Key takeaways
- Mega-cap stocks have led the market since 2014, but that era may have come to an end as a result of coordinated fiscal and monetary stimulus.
- Prices on the stocks of today's biggest companies seem to be justified by absolute and relative valuations—unlike the previous period of mega-cap leadership, which peaked in 2000.
- Looking at past bull markets, 1949–1968 and 1982–2000, I think we have reached the moment of "peak rate of change" for the broader stock market—the market could continue up but at a slowing rate.
- If we have reached "peak reopening," it wouldn't surprise me if stocks take a breather soon. It's not my base case but 2 historical analogs suggest that it could be a possibility.
With large-cap growth stocks taking back the lead in recent weeks (and in the process propelling the S&P 500 to new all-time highs), I figured we are due for a refresh of my Nifty 50 study. My previous update was last fall, and a lot has happened since then.
The original Nifty 50 era was the early 1970s. The cyclical bull market of the late 1960s had produced a huge bubble in retail speculation. Then, the recession of 1970 delivered a painful bear market. Having been burned by both the recession and the bursting of the speculative bubble of the late 1960s, the investors left standing were only willing to buy tried-and-true stocks with bullet-proof earnings. This handful of mega-cap stocks were referred to as the Nifty 50.
The mega-cap growth period since 2014 is the third such regime in 6 decades, with the previous 2 consisting of the original Nifty 50 era and the boom/bubble in tech stocks during the late 1990s. In my view, the latest era has been driven by the need for free cash flow (FCF) in a world of slow growth and low interest rates.
The chart below shows the relative return of the 50 largest stocks in the S&P 500 vs. the next 450 stocks using monthly data since 1962. As you can see, over the very long term, mega caps tend to lag the market, presumably because they tend to be boring, quality stocks with high P/Es (price-to-earnings ratios) and steady but not exciting earnings growth. But interspersed along that declining trend line are a few notable eras of mega-cap leadership.
Past performance is no guarantee of future results. Monthly data as of 04/18/2021. Monthly rebalance assumed. Source: FMRCo.
This current era may or may not have come to an end last fall when it became apparent that a new secular regime of coordinated fiscal and monetary policy may be upon us following the presidential election. Combined with the reopening of the economy following a prolonged pandemic-induced lockdown, the relative return of mega-caps took a pretty decisive turn.
Since then, the top 50 stocks have underperformed the bottom 450 by 1,455 basis points (bps) after having outperformed by 4,865 bps since 2014. A basis point is 1/100th of a percent.
As the next chart shows, at its peak, the Nifty 50 comprised 58% of the market cap of the S&P 500. As of March it was 55%. That peak was just shy of the 60% in 2000 and well shy of the 66% in 1973.
Past performance is no guarantee of future results. Monthly data as of 04/18/2021. Monthly rebalance assumed. Source: FMRCo.
Analysis of today's top 50: Growthy sectors and strong gains in earnings
Sector-wise, at the peak the growthier sectors—technology, health care, and communication services—made up 72% of the top 50, while they comprised only 30% of the bottom 450.
On the other side, the more value-oriented sectors comprised a mere 10% of the top 50, while making up 52% of the bottom 450. Those sectors are financials, energy, industrials, utilities, materials, and real estate.
While the current Nifty 50 era looks a lot like the late 1990s in terms of overall performance and sector composition, in terms of relative valuation the 2 eras are quite different. Back in 2000, the top 50 stocks traded at a P/E of 40.5x while the bottom 450 were 19.9x. That gap closed completely during the 53% bear market that followed. Today, the top 50 trade at a 32.9x multiple while the bottom 450 trade at 30.7x P/E. No huge gap this time around.
My conclusion is that the outperformance of mega caps since 2014 has been justified by an (almost) equally strong gain in relative earnings. So unlike the 1998–2000 period, the current mega-cap leadership has been justified by improving fundamentals and should, therefore, in my view, be more sustainable.
No bubbles but the market may have hit "peak rate of change"
This doesn't tell us whether or not the new Nifty 50 ended their 6-year-long dominance a few months ago, but what it does tell me is that there does not appear to be a valuation bubble.
That in turn suggests to me that even if there is a secular regime shift toward small caps and value (a distinct possibility based on the long-term charts), it may not produce the kind of catastrophic underperformance in mega-cap growth names which occurred following the 2000 peak. I believe it should be a smoother ride if there is no valuation bubble to burst.
So, where are we in the long wave of style rotation? Based on the secular bull market analog of 1949–1968 and 1982–2000, I think we have reached the moment of "peak rate of change" for the broader stock market; i.e., the market should continue to climb but at a diminishing rate of change.
How much of the reopening have markets priced in?
With the aforementioned renewed leadership in mega caps in recent weeks, the rotation into small caps and value appears to have been put on hold. This raises the important question of whether the grand reopening has been fully considered and incorporated by markets. It's worth remembering that getting the cycle right is not just about knowing what comes next. Equally important is knowing what's reflected in the price.
The question now is: Where do we go from here?
I don't know the answer, but anecdotally speaking, I think a lot of positive economic news is now reflected in the market. I flew back to California a few days ago, and between busy airports and planes, and a Santa Barbara brimming with activity, I can't imagine that a full reopening is not priced in at this point.
When I left Santa Barbara in February it was a ghost town. Now it's the opposite, just like the Fed's Weekly Economic Index (WEI) which hit a low of −11.43 in March 2020 and a high of +11.74 in March 2021. (The WEI tracks 10 economic indicators and offers a quick insight into the health of the economy.)
Peak reopening?
So have we reached "peak reopening?" By this I don't mean that the reopening itself has peaked, but that the rate of change in reopening momentum has peaked. Inflection points are always about changes in the second derivative.
If we have reached "peak reopening," the equity bull market may take a breather soon. It's not my base case, and a 10%–15% correction wouldn't derail my bullish outlook, but it's interesting that the 2 market cycle analogs that have worked with near perfection during this cycle are both showing that a correction could be imminent.
The first analog is the global financial crisis. It has worked perfectly in guiding us along the timeline of when price bottoms vs. when earnings bottom. After a 74% gain from March 2009 to April 2010, the market fell 17% that summer, before resuming the bull market.
The second is the WWII analog from the 1940s. That has been my go-to analog for over a year now, and it has nearly perfectly described the fiscal/monetary regime in which we find ourselves today. After a 53% gain in real terms, the S&P 500 fell 13% from July 1943 to November 1943.
Past performance is no guarantee of future results. Weekly data as of 04/18/2021. Source: Bloomberg, FMRCo.
Will history repeat? I don't know, but after a 90% gain in 13 months and with the possibility that we have reached "peak reopening" for this cycle, it wouldn't surprise me if the bull market (and the rotation) takes a breather here.
About the expert
Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation. He joined Fidelity in 1995 as a technical research analyst.
