INSIGHTS

HISTORY MAY NOT REPEAT, BUT IT OFTEN RHYMES

Jia Ye, PhD
|
August 4, 2020

Several attributes of the stock market today are reminiscent of the period near the end of the tech bubble twenty years ago. Growth has shot the lights out, value has struggled, and market share has become increasingly concentrated. At the peak of the tech bubble in March 2000, the tech sector, a combination of Information Technology and Telecomm (or Communication Service), accounted for more than 40% of weight in the S&P 500 Index. The price-to-book spread across the GSCI sectors today is nearly as wide as the pre-bubble level. The top five firms, Microsoft, Cisco, GE, Intel, and Exxon Mobil, accounted for 18% of the S&P 500 Index in March 2000. Today, the tech sector constitutes a similarly high 38% weight in the index, and the top five companies, Apple, Microsoft, Amazon, Alphabet, Facebook, command an even larger presence in the S&P Index, 22%.

Given the similarity in conditions, it is worth briefly re-examining market trends before and after the tech bubble burst in March 2000. Over the 12 months leading up to that memorable March, companies in the top quintile of long-term growth expectation were up a whopping 50%, while those in the bottom quintile were up a meager 4%. In the following 12 months, however, there was a stunning reverse of fortune: firms in the top quintile of long-term growth expectations gave up all the return earned – and then some – whereas companies in the bottom quintile tripled their performance.

FIGURE 01 - PERFORMANCE OF TOP AND BOTTOM QUINTILE BASED ON LONG-TERM GROWTH (LTG) EXPECTATION, S&P 500 UNIVERSE

Sources: Capital IQ, Bloomberg

We saw a similar reversal from the perspective of value, whether measured by book/price (shown), earnings/price, or other valuation ratios. In the 12 months leading up to March 2000, companies trading at high prices compared to their fundamentals did very well, but then gave back all gains during the following year. On the other hand, value companies staged a comeback after the burst of the tech bubble.

FIGURE 02 - PERFORMANCE OF TOP AND BOTTOM QUINTILE BASED ON BOOK-TO-PRICE (BP) RATIO, S&P 500 UNIVERSE

Sources: Capital IQ, Bloomberg

Concentration also fared poorly after the tech bubble, while diversification turned out to be the overall winner.

FIGURE 03 - PERFORMANCE OF EQUAL-WEIGHTED AND CAP-WEIGHTED S&P 500

Sources: Capital IQ, Bloomberg

So should we worry about the high market concentration and hefty valuations? Some believe this time is different. Today’s mega-cap firms have a higher share of market earnings and a faster growth rate than their counterparts twenty years ago. They have significant cash cushions, and are able to borrow at near-zero rates to finance their new projects. As a whole, the tech sector today is also more profitable than the tech sector twenty years ago, powered by the broader trend of automation and technology innovation since the Great Financial Crisis. Additionally, the COVID-19 pandemic may result in a paradigm shift in work and social behaviors, e.g. remote working and social distancing, which will likely benefit the tech sector and many mega-cap firms disproportionally.

Even so, it is unclear that large-cap growth can continue to deliver on their elevated expectations. With the trajectory of the global economy dictated by our success in containing the coronavirus, uncertainty abounds. We don’t know how the second wave will play out; we don’t know how the virus will evolve; and we don’t know when reliable vaccines will be available. The radical uncertainty is prompting businesses to hold onto cash, withhold investment, and abandon financial guidance. It is also encouraging consumers to increase savings and forsake desirable but unnecessary activities. In the current circumstances, investors will be well served by sticking to basic principles: investing with ample margin of safety and diversification.

 

For index definitions and trademark language used in this publication, please visit https://www.firstquadrant.com/index-definitions for further information.

Past results are not indicative of future investment results. Commodities trading involves substantial risk of loss.
© First Quadrant, L.P. 2020. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, L.P. only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

Related Posts