“If something cannot go on forever, it will stop.” So states Stein’s law, promulgated by the chairman of President Richard Nixon’s Council of Economic Advisers, Herbert Stein. While it is a tautology, Stein’s Law remains a useful reminder that seemingly unstoppable trends have limits.
The latest application appears to be the apparently irresistible outperformance of giant technology stocks that have not only led other equities higher, but also dominate the major averages that are weighted by market capitalization, such as the
The good news is that the strength of the five biggest stocks—
(GOOGL)—has lifted the S&P 500 to within 5% of its record set last February. The bad news is that this concentration recalls past peaks when the behemoths’ outperformance couldn’t go on forever.
The FAAMG stocks, as Goldman Sachs’ strategy team, led by David Kostin, dubbed the big five in a research note published this past week, have added more than one-third to their market values in 2020, during the sharpest recession on record and a pandemic. Their performance had allowed the S&P to be up 2% for the year when the report went to press, while the other 495 companies in the index were down 5%, on a cap-weighted basis.
That’s resulted in the highest concentration among the top five stocks in the market in decades, the Goldman strategists continue.
These five names—FAAMG is a variant of FAANG, without
(NFLX)—now account for 22% of the S&P 500, up from 16% a year ago and 18% at the peak of the dot-com bubble. It’s interesting to note how the names have changed since then. Only Microsoft is a returning chart topper from two decades ago, while the glory days of
(INTC) are long gone.
Simple arithmetic limits the continued outperformance of the biggest names, the Goldman team observes, because many portfolio managers have 5% limits on holdings of any given stock. The strategists’ analysis shows that the average large-cap mutual fund already has a 5% position in Microsoft and about 4% positions in the other big four names.
The strength of the FAAMG stocks is that they’ve been supported by fundamentals and a macro environment that has rewarded their financial and operational advantages in a slow-growth world. An improvement in the economic outlook, however, would likely lead to a rotation from growth to cyclical value stocks. Antitrust threats also pose risks for these market leaders.
Given the big five’s outsize influence, they could weigh on the averages on the downside, as well. “For example, if the FAAMG stocks declined by 10%, in order keep the trading flat, the bottom 100 S&P 500 stocks would have to rise by a collective 90%. This dynamic explains why narrow market breadth has often preceded large drawdowns in the past,” the Goldman note says, using one of the Street’s favorite euphemisms for the word “losses.”
The market got an inkling of this effect Thursday when sharp drops in the big tech names sent the
SPDR S&P 500
exchange-traded fund (SPY) down 1.19%, while the
Invesco S&P 500 Equal Weight
ETF (RSP) was off just 0.16%.
To be sure, the big names aren’t the only ones that have run into some resistance.
Biotechnology stocks had joined in the rally, boosted by hopes for a coronavirus vaccine or treatment. But the
iShares Nasdaq biotechnology
ETF (IBB) slumped 5.2% on the week, after hitting a 52-week high Monday.
The rationale for the heady equity valuations remains the historically low level of interest rates, which makes a stock’s stream of future earnings more valuable. The benchmark 10-year Treasury note ended the week just above its March 9 closing low yield of 0.569% while the yields on three-, five- and seven-year T-notes slid to new record lows. Perhaps more importantly, real yields—that is, after deducting inflation—hit their most negative levels since 2012.
Negative real yields boost the value of all manner of assets, notably gold, which traded at a record level above $1,900 an ounce this past week. Conversely, the greenback slumped, with the widely followed U.S. Dollar Index ending near a two-year low.
None of that will change when the Federal Open Market Committee meets this week. The central bank is certain to continue the policies that have put yields at these historic lows, including pegging the overnight federal-funds target near zero and maintaining its securities purchases. More important is what might be said, including forward guidance about keeping rates pinned to the floor until inflation lifts or unemployment subsides.
The bigger question will be what to do as another fiscal cliff looms, with unemployment support payments in the Cares Act due to run out July 31 while the Trump administration and Congress wrangle over a phase four stimulus package. The stimulus negotiations will take place against the backdrop of rising coronavirus cases and the release of a second-quarter gross domestic product report that probably will show a record-shattering decline at an annual rate of 30% or more.
That’s ancient history. Real-time data, such as that on the population’s mobility—are people going out or traveling?—TSA checkpoint numbers, and OpenTable restaurant reservations, show “the spike in virus cases is indeed sucking the oxygen out of the robust economic recovery of the past two-and-a-half months,” writes Scott Anderson, the chief economist of Bank of the West.
While Washington might continue to ignore those signs, Stein’s Law suggests the dithering won’t go on forever. A drop in the stock market has shown that it has the ability to concentrate politicians’ minds, if only to cover their rear ends.
Write to Randall W. Forsyth at email@example.com