After a sharp rebound in late March through early April, the S&P 500 (which the C Fund is indexed to) has been in a relatively sideways pattern for the past month.
Specifically, the S&P 500 has fluctuated between the 2800’s and 2900’s in a choppy and slightly upward pattern over the past four weeks, although on Tuesday it breached the psychologically important 3,000 threshold as well as the 200 day moving average on hopes of vaccine development and optimism surrounding moves to reopen areas of the economy around the country and beyond.
The MSCI EAFE index of developed international markets, which the I Fund follows, has experienced a much shallower recovery so far, and remains below its Q4 2018 lows, unlike the S&P 500:
Similarly, U.S. small caps, depicted below by the Russell 2000 index (which is similar to but not identical with the S Fund), have slumped relative to the C Fund:
This has certainly been an environment where it has paid to be a big American stock. Small American stock and foreign stocks performed poorly on the 3-year charts, but big American stocks have held up better.
And so, we have record amounts of concentration in the U.S. stock market, with a handful of mega-cap companies reaching concentration levels as a percentage of the equity market not seen since the 1980’s. We also have a growth-over-value divide that is at 20-year highs, and we have a US-over-international performance gap that is the best it has been in at least 25 years.
Even among the large American companies though, the performance gap is significantly due to higher valuations rather than fundamentals.
The next chart shows the S&P 500 price (black line) relative to consensus analyst forecasts for aggregate S&P 500 earnings, and the 20-year average valuation multiple on those earnings (blue and orange lines):
Over this twenty-year period, the S&P has, on average, traded at a 17.55x blended adjusted price/earnings ratio, but is currently at just 19.86x. Even as analyst expectations for 2020 have come down, S&P 500 stock prices have bounced back up and have defied gravity in recent months.
It remains to be seen how this will reconcile in the year or two ahead. Perhaps the S&P 500 will push forward, with investors looking ahead to higher expected 2022 earnings levels. Or it could stagnate for a while in a choppy sideways pattern until fundamentals catch back up, or it could fall as much as 20-30% in 2020/2021 to get back to “average” valuation levels before shooting back up.
As always, investors would do well to make sure they are diversified and that they understand the potential risks and rewards of their investment allocations relative to their investment goals and time horizons.
Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.