Some Notable Events That Grabbed My Attention This Week

The steady rise of the market indexes is hiding some interesting developments in the markets.

The largest stocks are dominating the indexes more than usual. In a capitalization-weighted index such as the S&P 500, the 10 largest stocks usually account for a high percentage of the index and its performance.

Now, the five largest stocks in the S&P 500 account for 17.3% of the index, the highest percentage since at least 1990. The only period that was close was 2000 when the five largest stocks were 17.0% of the index.

Microsoft (MSFT) is the only stock to be among the five largest in the S&P 500 both times. The other four stocks today are Apple (AAPL), Alphabet (GOOG), Amazon (AMZN) and Facebook (FB). Back in 2000, the other four stocks in the top five were General Electric (GE), Cisco (CSCO), Walmart (WMT) and Intel (INTC).

As in 2000, today’s five largest stocks have much higher valuations than the rest of the market. The price-earnings ratio (P/E) of the top five stocks today is 27.80 compared to 22.26 for the rest of the index.

I don’t take that as a sell signal. The spread between the P/E of the top five stocks and the P/E of the rest of the market is not nearly as wide as in 2000. Yet, there have been only six times since 1990 when the P/E spread between the top five stocks and the rest of the market was wider than today.

In late 2019, there were signs that the dominance of the largest stocks might be ending. Smaller company stocks were starting to outperform the largest stocks. As we entered 2020, however, that trend stopped. The largest stocks accelerated ahead of the rest of the indexes. The trend of dominance by the largest stocks that has been in place since 2015 continues.

Turning the Tables on Amazon

Most retailers have had a tough time in recent years. You’ve seen the stories about the record number of stores closing and retailers going out of business.

Most analysts believe the strength of Amazon (AMZN) is the major cause of retailer distress. Amazon’s advantages really kicked in after the financial crisis. AMZN stock surged, and consumers steadily did more and more of their shopping online.

But not all retailers are suffering. In fact, 2019 was a comeback year for stocks of many traditional retailers. Stocks of traditional retailers rose an average of 92% in 2019, according to Bespoke Investment Group. AMZN increased only about 22% in 2019.

Winning retailers included Walmart, Costco, Best Buy, Ross Stores and TJ Maxx.

These retailers benefited from the decline of many marginal competitors. The traditional retailers also are learning to compete with Amazon by establishing strong online presences and improving customer service and other features Amazon can’t offer. The Wall Street Journal had an article in December delving into Walmart’s steps to counter Amazon. At the same time, Amazon was weakened by some bad publicity.

It will be interesting to see if 2019 was a turning point or merely a pause in Amazon’s steady increase in market share.

Conflicting Measures of Profits

There are two widely followed measures of business profits, and lately they’ve been telling different stories.

Earnings reports by the S&P 500 companies are the most widely reported measures of corporate profits. When most investors refer to profits, they refer to the corporate earnings reports, and those reports move stock prices.

Another measure is issued by the Bureau of Economic Analysis (BEA). The BEA estimates pretax domestic profits by using tax data and other information.

The S&P 500 earnings declined in late 2019 but in general they’ve been rising the last five years. After-tax profit margins hit records in 2018 and declined only a little in 2019.

The BEA data, however, say profits declined 13% over the last five years. That’s the biggest decline outside of a recession since World War II. The BEA data also say that profit margins are falling.

This divergence can be worrying, because there was a similar divergence between these measures just before the technology stock crash in 2000.

Some economists have more benign explanations.

They say large companies are able to use strategies that reduce taxes but also reduce their profits as reported in the BEA data.

Another explanation for the divergence is that large companies are dominating more and more of the economy. The large companies make up the S&P 500 and the earnings reports. The BEA tries to capture the entire economy, not only the S&P 500. The gap between the two measures reflects the increasing dominance of large companies, sometimes called the winner-take-all economy.

The Data

Retail sales continue to be solid. Overall sales increased 0.3% in December, but after excluding autos sales increased a strong 0.7%. That compares to no change in November for sales excluding autos.

Solid retail sales match Consumer Sentiment reported by the University of Michigan. The Consumer Sentiment Index was 99.1 for January, declining slightly from 99.3 in December. The December reading was a seven-month high. In January, current conditions increased a little, but expectations declined.

Homebuilders remain very optimistic. The Housing Market Index from NAHB was reported at 75, compared to 76 last month. Last month’s number was the highest since June 1999. Builders say they still are constrained by shortages of labor and land. Also, high construction costs turn off some potential buyers.

Homebuilder optimism is justified by the latest data. Housing starts were an annualized 1.608 million compared to expectations of 1.38 million. That’s a 16.9% monthly increase and the strongest month for starts since December 2006. Since 1998, there have been only two times that the month’s starts exceeded expectations by a bigger amount.

Existing home sales increased by 3.6% in December and 10.8% for 2019. This is a big turnaround for sales. They now have six consecutive months of increases over 12 months, which followed 16 months of declines in 12-month sales. Sales would be higher, but the inventory of homes for sale remains low.

House prices increased by 0.2% in November, according to the FHFA House Price Index. Over 12 months, they increased 4.9%.

There was another sign of a recovery in manufacturing. The Philly Fed Business Outlook Survey was reported at 17.0, compared to last month’s 0.3 and expectations for a modest improvement.

Industrial Production was more mixed. The headline number was a decline of 0.3%, compared to last month’s 0.8% increase. In addition, last month was revised down slightly from the originally reported 1.1% increase. This decline in production was due to a combination of weakening auto production and reduced utility output due to warmer-than-usual weather in December.

The manufacturing component, however, had a 0.2% increase compared to a 1.0% rise last month (revised down from the original 1.1% jump).

The Leading Economic Indicators from the Conference Board declined 0.3% in December. Compared to a revised 0.1% increase for November. The index fell four of the last five months. Manufacturing data have been the weak part of the indicators while other factors are strong. The Conference Board reported the data point to about 2% growth for the first part of 2020.

New unemployment claims declined another 10,000 last week. The four-week average also dropped. This week claims increased 6,000. The recent declines erased the surge that occurred in December and brought total new claims back to the range they’ve been in for a while.

The Job Openings and Labor Turnover Survey (JOLTS) found that in November the number of job openings declined by 4.3% from October. That’s the largest monthly decline since August 2015. The number of job openings now is at its lowest level since February 2018.

Another negative in the report is that the so-called quits rate hasn’t changed much throughout this recovery. The quits rate usually increases as the economy gains momentum, indicating that higher-paying jobs are plentiful and workers are confident enough to leave jobs in search of better work.

The Markets

The S&P 500 rose 0.06% for the week ended with Wednesday’s close. The Dow Jones Industrial Average gained 0.56%. The Russell 2000 increased 0.11%. The All-Country World Index (excluding U.S. stocks) was unchanged. Emerging market equities declined 0.55%.

Long-term treasuries rose 0.22% for the week. Investment-grade bonds increased 0.66%. Treasury Inflation-Protected Securities (TIPS) fell 0.07%. High-yield bonds declined 0.08%.

On the currency front, the U.S. dollar increased 0.34%.

Energy-based commodities lost 1.83%. Broader-based commodities declined 2.17%. Gold rose 0.13%.

Bob’s News & Updates

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