Feelings about this topic can get extreme at times and there is no shortage of opinions out there.
QQQ, the large ETF tracking the NASDAQ, has risen 65% since the Christmas Eve drop in 2018. Facebook, Amazon, Netflix, Microsoft, Apple and Google (FANMAG) collectively make up the largest portion of the S&P 500 index in terms of concentration that has been seen since the dot com bubble. Taken in isolation, it sounds like we could be in bubble territory, and most major bull markets have ended in a bubble. However, we must remain disciplined in our analysis. No one wants to be holding the hot potato when the timer goes off and the next bear market begins.
At first glance, looking at a chart of QQQ compared to the NASDAQ in 1999, it looks strangely similar. The differentiator is that more stocks in the NASDAQ are trading higher and trending higher than in 1999. Right now, market breadth is healthy compared to 1999. Bubbles tend to present themselves when the index rises but the average stock is falling. That has yet to be observed. Here is a comparison chart illustrating these facts.
In considering how concentrated the S&P 500 has become, it is interesting to note that we are indeed showing the highest concentration since 2002. The S&P 500 is composed of stocks based upon their market capitalization, which is just the number of outstanding shares multiplied by their current stock price. As stock prices rise and/or number of outstanding shares per $ of price falls, their allocation in the index rises (and vice versa). This means the FANMAG stocks, collectively make up much of the top 10 stocks in the S&P 500 Index. The top 10 stocks (out of 505 stocks in the index) comprise nearly 25% of the index today! Here is a chart showing the historical concentration of the top 10 stocks in the S&P 500 Index from 1972 to present.
In isolation, this could be a cause for concern, but when we look at historical gains in the FANMAG stocks versus historic bubbles, the gains have been much steadier! Typically, steadier gains are less likely to illustrate bubbles. We have had monetary policy and fiscal stimulus in 2019 that was nearly unprecedented in the past 40 years absent a recession. The market absorbs money where it is mostly likely to be profitable. That has been in Large-Cap US Growth stocks. These are likely more of a reason for the higher concentration in the S&P 500 and the run up in the QQQ ETF.
The data does not yet support that this market is in bubble territory. However, that does not mean markets cannot be subject to corrections. Caution is advised when interpreting this type of data. All it really tells us is that it is possible to go higher, not that it is guaranteed to go higher.
We are always interested in likelihood of outcomes. We are in a year where there are lots of headline risks, which means there are many opportunities for corrections in the market. There are also reasons why markets can march higher. It is strongly recommended that you understand the risks of any strategy you are implementing and that you make sure that you are comfortable with the possible outcomes.
Bubble talk makes great news conversation. Having some facts to examine is also very helpful! Staying on the side of the data is a far more secure footing than mere feeling and anecdotal comparisons.
Copyright 2019 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Right Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo
Investment advisory services are offered through BCJ Capital Management, LLC., an SEC Registered Investment Adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed, and past performance is no guarantee of future results. For specific tax advice on any strategy, consult with a qualified tax professional before implementing any strategy discussed herein. BCJ FG 20-23