The stock market has been dominated by a select group of large companies this year. Eight in particular, including Apple, Microsoft, Amazon, NVIDIA, the two share classes of Alphabet (Google), Meta (Facebook), and Tesla, have seen their prices surge. While they are not necessarily the eight best performers, their strong returns, paired with their large weights within popular indices like the S&P 500, have resulted in an outsized impact on the overall market’s return.

We have discussed this group of stocks in a previous post (here). Generally, much of their strong performance can be attributed to rising valuations rather than improved business results. This can be observed in the chart below, which illustrates the change in the price-to-earnings (P/E) throughout the course of the year.   

Source: Morningstar Direct. P/Es are based on monthly data from 12/31/2022 through 6/30/2023. The selected stocks include AAPL, MSFT, AMZN, NVDA, GOOGL, GOOG, EMTA & TSLA. The blended P/E was weighted by their weight in the iShares Core S&P 500 ETF as of 7/10/2023.

While the price paid for the broad market of large and small-cap stocks (light blue and green lines, respectively) remains essentially unchanged, it has exploded higher for the selected stocks (dark blue line). In fact, it has nearly tripled in just the first six months of the year! This is a dramatic increase in a short period. Again, shares of these companies are not rising for fundamental reasons, such as improved past earnings results. Instead, their prices are rising because investors are becoming more optimistic and have been willing to pay an increasingly higher premium.

Dimensional Fund Advisors (DFA) recently published an interesting chart. It looks at the performance of the largest ten companies in the market before and after making the move into the top ten. This graph is particularly relevant here because the eight stocks we have been discussing currently occupy the top eight spots within the S&P 500.

Source: Dimensional, using data from CRSP.⁽¹⁾

Since the 1920s, the average return for the stock market has been about 10%. As the above chart illustrates, stocks tend to dramatically outperform the market in the years preceding their entry into the top ten. The story changes when you analyze relative performance AFTER the companies have entered the top ten. Since the 1920s, the high-flying stocks that make it into one of the top spots have gone on to underperform over the subsequent years.

Of course, a few of the top stocks today have been in the top ten for years and have continued to outperform the market. It’s certainly possible that their strong relative performance can continue. Lofty valuations make share prices vulnerable to even small bumps in the road, however, and each of these eight stocks is sporting a substantial premium over the market. This could ultimately lead to today’s high-flyers conforming to the historical pattern of underperformance.  

Week in Review

• According to FactSet, 51% of the S&P 500 has reported Q2 results as of last Friday’s close. The earnings growth rate, blended between companies that have already reported with the estimates for those that have yet to report, is at -7.3% year-over-year. Expectations for the earnings growth rate at the onset of earnings season was -7.0% year-over-year. Earnings growth is the fuel that powers the long-term appreciation of the stock market. For the current rally to be sustainable, earnings will have to return to a positive growth rate.
• Last week saw some big economic developments. The pace of economic growth for the second quarter surprised to the upside, coming in at 2.4% (expected 2.0%). Personal Consumption Expenditures(PCE), the Fed’s preferred measure of inflation, increased 3.0% from a year ago. Meanwhile, Core PCE, which excludes the volatile food and energy components, increased 4.1% YoY. This marks the slowest pace of ‘Core’ price increases since September 2021. Finally, the Fed increased the benchmark federal funds rate by 0.25% to a range of 5.25%-5.50%, the highest level in 22 years.
• This will be another big week on the economic data front. Look for an update on job openings and manufacturing activity on Tuesday, jobless claims and service sector activity on Thursday, and the all-important jobs report on Friday.

Hot Reads

Markets

• Key Fed Inflation Rate Falls to Lowest Annual Level in Nearly 2 Years (CNBC)
• GDP Grew At a 2.4% Pace In The Second Quarter, Topping Expectations Despite Recession Calls (CNBC)
• Federal Reserve Raises Interest Rates To 22-Year High (WSJ)

Investing

• Everything is Cyclical (Morgan Housel)
• Underperforming Your Own Assets (Barry Ritholtz)
• On Year Returns Don’t Matter (Ben Carlson)                                     

Other

• Terence Crawford Stakes Claim As the Best Boxer of His Era With Win Over Errol Spence (Sports Illustrated)
• Justin Thomas, Adam Scott and 9 Other Notable Players on the PGA Tour Playoff Bubble (Golf Digest)
• What Happens When You Stop at One Glass of Wine a Day (WSJ)

Markets at a Glance

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Economic Calendar

Source: MarketWatch

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