Aptus 3 Pointers, November 2023

by | Dec 5, 2023 | Market Updates

Given the popularity of our weekly Market in Pictures, we thought it made sense to pick out a few and go into more detail with our PMs. In this edition, Dave and John Luke will spend a few minutes on each of the following:

  • Equal-weighted S&P 500 vs. Cap-weighted
  • Zweig Breadth Thrust Signal (ZBT)
  • Latest Inflation and rate thoughts

Hope you enjoy, and please send a note to [email protected] if there’s a particular chart/topic you’d like to see covered next month. Time to swing it around!

Full Transcript

Derek:

Just at the end of November here, coming back from Thanksgiving and wanted to do our monthly recap of some of the charts that we’ve put out there over the past month. Got Dave Wagner here, CFA and equity-focused PM and John Luke Tyner, CFA and fixed income focused PM. And I’ll read our disclaimer, which is the opinions expressed during this call are those of the Aptus Capital Advisors Investment Committee and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. More information about Aptus’ investment advisory services can be found in its form ADV part two, which is available upon request.

So what we’ve been doing these past few months is just going through some of the more interesting charts. And maybe ones that… Maybe just to give a little more depth on actually what’s being said on the chart. And then how that plays out going forward, what that actually means. So one of the three that we’re going through is just talking about the average stock. I mean, everybody’s talked about Mag Seven over and over and over again, but what does it mean for the rest of the market and what does it mean for portfolios? I don’t know if one of you wants to jump in and kind of walk us through. We’ve got two charts on this page. One more of a shorter term, one more of a longer term. So maybe give us a little walkthrough here.

Dave:

Yeah, I think we’re all probably hoping that the market becomes what in our idea, a little bit more rational that it’s a market of stocks, not just a stock market. And I know that we’ve probably beaten this horse dead just a few times talking about the Mag Seven, which continuing to drive return. Which I think is somewhat warranted this year if you actually look at a lot of the earnings per share growth for the Mag Seven stocks, a year over year basis. But this top chart is just showing you that only 26% of the stocks in the S&P 500 are outperforming the S&P 500 just this year. And that this is the most concentrated the index has ever been from a market return standpoint. And I know that we’ve continued to have a lot of commentary out there taking a small style tilt into more your S&P 500 equal weighted portfolio, or strategy, pardon me.

And that’s just the same exact 500 stocks that are in the S&P 500, but they’re not market cap weighted. They’re actually equal weighted. And when you look at the valuation between the two, they still tend to look pretty palatable, the average stock. I mean, I think the equal weighted S&P 500’s trading net 2024 earnings just sub 15 while the S&P 500 is trading closer to just above 18.

And I think, one of the big stats that why we continue to want to talk about this because it’s kind of going unheard of in my mind, at least if you listen to anywhere on TV. It’s that the average stock in the Russell 3000 is down 28% since it’s 52 week high. That another way, I think it’s about 53% of the stocks in the Russell 3000 are still down more than 20% versus their 52 week high. So you’ve seen a lot of pullback in the average stock for a continued amount of time. I mean as of today, the S&P 500 is up over 20% and the S&P 500 equal weighted portfolio is only up about 5% showing about a 15% relative spread right now. So it continues and we saw that just this month. I mean the S&P 500 yet again beat the RSP 500 so far here in November.

John Luke:

Yeah, and I don’t know that it’s really an indicator that it’s going to flip immediately, but you have to look at that bottom chart and know that a equal weight’s actually outperformed cap weighted over time. And while this valuation gap and performance gap is stretched, we do think that equal weight can provide some compelling diversification for portfolio construction. And that obviously makes sense because we’ve dotted in most of the portfolios.

But I do think that a more palatable way to sort of get involved in the market is the equal weight S&Pif you’re looking for market type of exposure. And it does give the opportunity for maybe some sort of mean reversion that could play out but still giving you a decent entry point given those valuations that Dave spouted off.

Derek:

I would also say, just my reading of this, you can look at this top chart in a couple of different ways. I think the bottom chart is pretty clear in that over the long haul, these really shouldn’t… You shouldn’t see a big divergence. It’s the same. It’s 500 stocks, it’s not… Or 504, whatever the number is. But it’s not something where you’re going to see decades of a major divergence between what the typical stock does and what the larger cap weighted stocks do.

But one thing you can do if you have a bearish till, you can extrapolate and say, “Oh well late nineties we had this kind of narrow market and the market crashed in the.com bubble.” But I mean that’s one. You have sample size of one. I think that the clearer picture to me is that this entire graph going back almost 30 years, you’re generally in that 45 to 55 range almost every single year other than this year and two others, three others, are basically saying you’re going to have around half the stocks do better, half the stocks do worse.

That can either flip to mean the broader market’s going to catch up to the upside or the big mega stocks are going to come down to the downside. So I think it makes sense to have… Take a longer term approach, not really make a whole lot of predictions out of it, but just recognize that this year has been highly unusual and hopefully to your point with the valuations getting better on the 74% that haven’t beaten the S&P 500. Maybe that sets up for a little bit better year on the broader market.

John Luke:

Yeah, I think bottom line for people that are contributing monthly, probably pretty exciting time to be buying equated S&P.

Derek:

Yes. Perfect. All right. Another thing we’re going to go through, this is old school. I see the name Zweig. I know everybody knows Jason Zweig, Wall Street Journal reporter, who’s great writer, who’s great. Marty Zweig. For those of us that used to watch Wall Street Week, I mean he was a legend back in the day and he was on in the late eighties and I think he was Liz Ann Sonders’ first boss, who we all know is like the Schwab strategist now. She does great work.

But he was the one that really came up with the terms, don’t fight the fed, don’t fight the trend. Things that really have persisted over the decades. And so I see the name in there. I don’t know if one of you wants to go through… What are we looking at? I see a lot of green on here. So what is this? What are you showing us?

Dave:

I’ll take first stab John Luke. And what this is, this is a Zweig market breath indicator in a nutshell. It’s just a momentum based indicator. But for those more math nerds at home, it’s basically calculated by taking the 10 day moving average of the number of advancing issues divided by the number of advancing issues, plus the number of declining in issues. That’s a lot of mumbo jumbo that I basically said there. But in a nutshell it’s just a measurement of momentum. And what this is just stating is that this past month, in my mind, I would consider this to be more of a right tail event because I don’t think many people heading into this month thought that the S&P 500 could go up 9% to the tail of it being up now 20% year to date.

But what it’s just showing is, when that Zweig market breadth, the thrust. That’s hard to say. I apologize. Signal gets triggered. It’s only happened a handful of times since World War II. It tends to continue strength of the market as a whole. And if you compare that really to our last slide of just showing that, “Hey, you know what the average stock is in a technical bear market right now.” Kind of what Derek said there, “You can either see the average stock regaining its footing or seeing the Magnificent Seven losing its footing.” Or I guess, you could have both of those situations happen.

But there’s still a lot of opportunity out there in this market to remain bullish, even though I think you’re getting a lot of sentiment out there is quite bearish on the macroeconomic front. It just shows the importance of having the right structure in place at the asset allocation level that you could still want to participate in these right tail events, much like what we’ve seen this year.

John Luke:

And you look at that chart and you’ve got a couple dates in there that are pretty familiar. So like the forties inflationary period with the market sort of ramping off of that. Again, the seventies and early eighties period where market was very friendly. And then obviously after the financial crisis and some of the QE times where markets have really rallied since following the financial crisis broadly.

But I think, the other sort of maybe tinder on the fire could be sort of the money market allocation that we’ve seen. I think there’s somewhere between five and $6 trillion that’s flowed into money markets over the past year or so with rates higher. And I do think that there will be some sort of indicator where it took rates to get to about 4% where before depositors started pulling money out of banks and then chasing money markets and T-bills. Where if rates were to fall back lower, I think that you could have a lot of dry powder on the forefront of things where if rates do move lower that stocks could have another sort of jolt forward with just money getting shifted around back into risk assets.

Dave:

And I think John Luke, I think one thing that JD says really well when talking about our asset allocation, he talks about the impact of returns are more important than the frequency of returns. So you got to prepare for the left tail situation and also the right tail situation. But I read a pretty interesting fact showing that these right tail situations, much like what we’ve seen month to date with a market up about 9% here in November so far, is that if you look at the S&P 500, the percentage of advances each year. When the market’s up 20% or more in a calendar year that’s happened 36% of the times dating back to the 1930s. Market is up about 21% of the time between the range of up 10% to up 20%. And if you look at a market that’s down 10% or more over a calendar a year, that only happens about 12% of the time. So it just really shows the impact is very much more important than the frequency, not just on the downside but also the upside.

John Luke:

Yeah, I think really the only other point that that is maybe obvious. But market’s flat for the past two and a half years or relatively flat. And I do think that maybe that catch up or adjustment period has been playing out, right? Stocks are nominal assets where they have the ability to grow their earnings and grow their pricing power and things like that that give them levers to offset just the cumulative cost of living, which will ironically be the next slide. But I do-

Dave:

No, I was just… Sorry to cut into you there. But John Luke let’s just put ourselves in the seat of a lot of the advisors, our different partners on this call. I mean their clients always says, “What have you done for me here lately?” And you brought up a great point, JL. “Hey, market’s up 20% this year, but if you look at my returns over the last two years, they’re flat.” But it’s, “What have you done for me here lately?” It’s like, all right, market’s up 20%, we’re still flat over the last two years. It puts a lot of advisors and some of our partners in some very difficult conversations right now.

Derek:

So on that point that JL was going towards and the fact that not only are markets pretty flat, but costs have risen in pretty much every category. And while they may not be spiking like they were, they did hit pretty hard for a couple years. And it’s not like when inflation comes back to 2%, it doesn’t mean prices are falling. I mean, it just means they’re stable at a high level. So maybe there’s a lot of small numbers and different lines on here. You want to walk us through a little bit of this.

John Luke:

So this chart looks back to the beginning of March 2020, sort of the forefront of the inflationary period following the pandemic and the lockdowns. So what it’s looking at, the green line is CPI, food at home, the blue line is CPI, all items. And the orange line is CPI, commodities, X food and energy. So basically, a core type of measure. And really what it’s starting or what it’s showing is just how high that inflation has gone up the last call at three years. Where the cumulative impact of inflation is what’s really starting to be felt by the consumers where, like Derek said, you’ve seen inflation slow down. Like this time last year inflation was pushing on double digits and now we’re back near three.

But the real impact is that the price of everything has gone up pretty drastically and that doesn’t really spare the consumer much relief whenever that inflation does peak its head a little bit lower because you’re coming off of such a big base. And I do think that how this relates to clients’ allocations is, this is longevity risk front and center. And the impact of cost of living, which arguably these numbers are probably understated to most budgets for folks living in the real world. But if you’re looking at the numbers, cumulative inflation of CPI all items is up over 20% in three years. That’s a pretty substantial impact of just the price of things and what that’s costing. And I think it really bears the need of making sure that we have enough risk in client portfolios and the overweight of stocks that we position in our allocations.

Because really you’ve got to have assets that can grow and while you get maybe a 2022 environment where everything’s bad and there’s really no place to hide, that’s really part of the investing journey of just as things happen. And I think, it just makes a point of trying to position the best you can to get and inject enough turn drivers into portfolios, enough growth into portfolios that really allow you to isolate from some of the impacts of cumulative inflation and cost of living.

And just a simple reminder here on the right side, fixed income and a rising cost of living environment is detrimental. Your G or your growth on fixed income is zero, but cost of living, we kind of laugh when we show charts that show a straight up like this cost of living. But you look at the cumulative one on the left and it’s pretty similar. And I do think that the allocations and how we’ve built portfolios will over time help deal with this factor.

Dave:

So as everyone knows, I always have thoughts on everything. But I’m not going to say them here because what John Luke’s talking about here in this situation with inflation. But more importantly, talking about its effect on an asset allocation level. It’s like the most utmost important thing you can take away probably from this three pointers. So if I was y’all listening instead of listening to me to talk for about a minute, I would just rewind the last two minutes and re-listen to what John Luke just said there. ‘Cause that is the most important talking point that a lot of y’all can have with your own clients.

Derek:

Well, and I think you’re tying back into that money market quote. When you look at that graphic on the right, the fixed income is not a compounding asset. I mean it’s an income asset. Like you said, it’s 0% grower inflation compounds, even when it’s low, it compounds like stocks do. And so there has obviously been a race into money market funds and people are just giddy to get five and a half percent and sit there and collect that without risk.

But there is that silent risk that when you get the crossover like that and the compounding of inflation takes place, I mean you got one of two things. If rates go higher, then your cost of living has gone higher, your expenses have gone higher, and you’re kind of falling behind from that side, if you’re locked into fixed income. And if you’re in money markets and rates go down, now you have a reinvestment risk where, “Yeah, it was cool, I got five and a half percent for a year or two, but now what if rates are 4%, 3%, 2%?” It’s not as exciting anymore and you probably have missed out on other opportunities.

So I think it’s important to kind of balance all that out. And that’s where these guys do a ton of work at the allocation level to make sure that, “Yeah, we’ve got enough safe capital. We’ve got enough growth capital. We have the income side taken care of.” So I don’t know if you guys have anything to add to that, but that’s kind of what pops out at me when I look at… You’re right though. It’s almost like this left graphic is showing a microcosm of the right graphic.

John Luke:

Yeah. And one trivia question for you, Dave, is inflation, when you get a cycle, does it typically just end after one wave higher or are there more oftentimes multiple waves? And I guess to put that in context, there hasn’t been a ton of samples, but we have… There is an answer.

Dave:

Well, the answer’s binary here, John Luke. It’s either yes or no. And we both know that answer. It tends to not just stop at one cycle of inflation. So hit us with those numbers.

John Luke:

So from studies that I’ve seen, about 87% of the time, it doesn’t end at one phase of inflation or one cycle of inflation. Typically, there’s two or three. And while phase one is obviously probably over with, I do think that you can’t overlook the fact that what if the Fed backs off too early and we do get some sort of re-ignition in inflation? And I think it just sort of compounds the point of making sure the asset allocations are built properly.

Dave:

Hey, John, Luke, if you could give a letter grade to Jerome Powell for how he’s handled this situation, what would you give him? What letter grade?

John Luke:

I don’t want to comment on that. I think he’s done a pretty good job the last 18, 20 months.

Derek:

He was behind after the first midterm, but he got-

John Luke:

Jerome was first and he’s probably gotten a B plus or A minus sense.

Derek:

Whoa.

Dave:

That’s higher than I would’ve thought, John Luke. I would’ve thought you’d said B minus or C plus. I’m probably rating the B plus A minus camp also.

John Luke:

Yeah, I mean we could spend another… We’ll turn it into six pointers.

Derek:

All right guys. Awesome. Thanks for running through it and hope everyone gets a lot out of it. Remember, fire away questions. If you have ideas for next month, we’re always up for it. So appreciate you guys helping out with this.

 

 

 

 

 

Disclosures

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security.

The opinions expressed are those of the Aptus Capital Advisors Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed.

Aptus Capital Advisors, LLC is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Fairhope, Alabama. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call (251) 517-7198. ACA-2311-18.

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