“History does not repeat itself, but it often rhymes.” Mark Twain
Current conditions
We have been talking to clients for the past year about the historically narrow advance of the market that has been driven by the excitement around Artificial Intelligence (AI) and the stocks that are beneficiaries of its development. Like so many past revolutionary technologies – from the computer to the cell phone to the internet – AI will undoubtedly impact the future, but it is very difficult to know exactly which companies will be the main beneficiaries.
Like many others, we find it difficult to ignore the similarities in the market’s rise over the past year and a half and the market of 1998-2000. The ’98-’00 time period was dominated by big Blue Chip companies such as Amazon, Apple, Cisco Systems, eBay, Corning and Network Appliance. Small cap stocks, value stocks and international stocks all significantly underperformed (Source – Y Charts). In addition, it seemed that almost anything that had “.com” in its name was sure to go straight up because it was involved in the internet! Of course, what happened next was what is now known as “the lost decade” because the S&P 500 which peaked in March ’00 did not make a new high until May ’14! Some of these companies – Cisco, Corning and Network Appliance, for example – still have not regained those previous highs despite years of earnings growth (Source – Y Charts). These are really well run companies, it was simply a matter of the stock price running wildly ahead of long-term earnings growth.
Today we have a similar phenomenon. The largest companies in the world – Microsoft, Apple, Nvidia, Amazon, Meta and Google – have seen dramatic stock price movement because of their leading position in AI. Apple, for example, is now a $3.5 Trillion (yes, Trillion!!) dollar company that is trading at its highest PE (price/earnings) ratio of 35.5 since 2008 (Y Charts)! Said another way, you could have purchased Apple at roughly half of its current valuation for much of the past 15 years. This isn’t to say that there is anything “wrong” at Apple, it is one of the most well managed, profitable and consistent companies out there; it has just gotten super expensive.
Do we think we are about to enter another 10+ year stretch of the market not making a new high? No, we do not believe that. While these mega cap tech stocks have made tremendous moves, the market’s overall valuation is still significantly below the ’00 levels. We do think that it makes sense to visit what worked during the lost decade. The underperformance of small caps, value stocks, and international previously mentioned in the run up to the ’00 peak, all dramatically outperformed the S&P 500 from ’00-’10 (Y Charts). This is precisely why we stay diversified; it is impossible to know when things are going to shift.
Another cause for concern is the extreme concentration in the largest companies in the S&P 500. The 10 largest companies in the S&P 500 now account for 33% of the market. The other 490 companies make up the remaining 67%. In the past when concentration has reached extreme levels, invariably the top 10 stocks weighting has pulled back to a weighting in the low 20ish% level (Goldman Sachs).
Opportunities
The dramatic outperformance of US large cap stocks relative to virtually everything else has created valuation discrepancies that are hard to ignore. Value stocks, small cap stocks and international equities all trade at significant discounts to US large cap growth stocks. Why does this matter? Again, a look back at the ’00 time period is helpful. As previously discussed, after the significant US large cap outperformance of the late ‘90’s, the S&P 500 was down -24% from 12/31/99 through 12/31/2009. During that same period small cap stocks were up 24% while international stocks were up 35+% (Y Charts).
We have attached two research articles that discuss current opportunities that are in line with our views. We hope these are useful to you in understanding why we continue to believe that globally balanced portfolios continue to make sense for long-term investors.