The narrow market leadership over the past 12 months has captured investors’ enthusiasm around an elite group of mega-cap tech stocks known as the Magnificent 7 (NVIDIA, Microsoft, Alphabet, Amazon, Meta, Apple, Tesla).
This group accounted for the bulk of last year’s market gains and currently trades at an elevated forward price-to-earnings (P/E) ratio of 31. But that is still much lower than the nosebleed valuations of the Four Horsemen in 1999, which had an average P/E of 851. And unlike the late ’90s, the outsized gains last year in mega-cap tech have been supported by strong earnings delivery in both absolute terms and relative to the rest of the market.
The recent broadening of the market gains, with the equal-weight S&P 500 outperforming its market-cap peer, and with value-style investments outperforming growth over the past month, is a sign that the bull market is not exhausted and may not be close to done yet. Conditions appear to be more like the 1995-1998 period rather than the 1999-2000. The average stock in the S&P 500 trades at a reasonable 16.7 P/E, with more stocks and sectors participating in the rally, and 10 of the 11 S&P 500 sectors are higher over the past three months. For comparison, three months before the burst of the 2000 tech bubble, seven of the 11 sectors were lower.
Given the uninterrupted nature of the stock-market rally since last November, a pullback and consolidation phase would be expected. But the combination of resilient economic growth, a reacceleration in corporate profits, and the upcoming start of a rate-cutting cycle at a time when financial conditions are already easing, may help sustain the expansion of this bull phase. This environment should be supportive for stocks, particularly in areas of the U.S. market that have lagged and carry lower valuations.
The stock market has been seeing some welcome rotation into other corners of the market. Granted the communication services (+12.2%) and information technology (+12.0%) sectors have paced year-to-date gains for the market, but the first half of March has seen the energy, materials, utilities, and consumer staples sectors exhibit relative strength. The same goes for the Russell 3000 Value Index versus the Russell 3000 Growth Index.
More specifically, mid and small-cap stocks look particularly interesting. Historically, they’ve been among the strongest-performing asset classes 12-18 months following the last Federal Reserve rate hike, but they’ve lagged since the Fed’s last hike in July of last year. Mid-caps tend to be more cyclical than U.S. large-cap stocks but of higher quality than small-cap stocks.
In addition, Metals, led by Gold, were quite strong. Gold closed at a new all-time high last week, its first-ever close above 2100. The breakout comes as Bitcoin closes in on a new all-time high as well.
Crude Oil has shown a remarkably subdued reaction to the Israel/Hamas war. That could change if other Middle East players become officially involved. One key new element appears to be Suadi Arabia’s inability to get all players on the same page for production cuts. Crude closed at its highest levels of the year on Thursday.
It should be and likely will be quite explosive, yet volatile in the days and weeks ahead. I’ll be closely monitoring the technicals and the trends to asses the possibilities going forward, as usual, and will keep you posted daily.
And remember, trade what you SEE not what you think!
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