Discover more from TKer by Sam Ro
The FAAMGs are more than just five stocks 🤨
Plus a charted review of the macro crosscurrents 🔀
Stocks climbed last week, with the S&P 500 rising 0.9%. The index is now up 8.6% year to date, up 16.6% from its October 12 closing low of 3,577.03, and down 13.0% from its January 3, 2022 closing high of 4,796.56.
Every once in a while, we’re reminded that a handful of stocks account for an outsized share of the S&P 500, and sometimes it’s the case that they’re responsible for driving the market’s gains or losses.
With mega-cap tech companies announcing earnings last week, we got a fresh reminder of these trends.
In a research note on Tuesday (via Notes), JPMorgan’s Dubravko Lakos-Bujas observed that the so-called FAAMG companies — Facebook (now Meta Platforms), Apple, Amazon, Microsoft, and Google (now Alphabet) — account for about 21% of the S&P 500. The $2.6 trillion Apple and $2 trillion Microsoft account for about 13%.
As you can see from Lakos-Bujas’ charts, this isn’t exactly breaking news as these companies have represented an outsized share of the S&P for the past few years.
What is news, however, is how they’ve been driving market returns this year.
On Wednesday, S&P Dow Jones Indices (via Notes) noted that “more than 5% of the S&P 500’s year-to-date gain of 6.6% gain is down to just seven tech titans,“ including Apple, Microsoft, Meta, Alphabet, and Amazon.
The thought of a few companies accounting for so much of the market is jarring, and it’s the kind of thing that you might consider a market vulnerability.
Two quick things: First, there isn’t much evidence that shows a relationship between market concentration and forward market returns (see chart). Second, market concentration isn’t unusual (see this and this).
“AT&T was 13% of total U.S. stock-market value back in 1932; General Motors, 8% in 1928; IBM, 7% in 1970,“ Jason Zweig, a WSJ columnist, wrote a little while back.
These five stocks don’t really represent five companies 🤔
It’s important to recognize today’s market leaders are structurally very different from the one-product companies of the past.
For example, Microsoft isn’t just about Office subscriptions. It’s got a portfolio of massive businesses including consumer products (e.g. Skype), intelligent cloud (Azure), gaming (e.g. Xbox), Bing, and LinkedIn. Microsoft even has a massive billion dollar advertising business.
I’d argue it’s imprecise to characterize FAAMG as five companies. Rather, they represent dozens of multi-billion franchises, which include products and services that permeate our lives in a wide variety of ways.
In the Jan. 30, 2022 TKer, I shared a cheeky disclosure section outlining how I (and maybe you) used these companies’ myriad of offerings. My point was that while I may use an individual product or service increasingly or decreasingly, it would be much more complicated and unlikely that I would separate myself from one of these companies outright.
From that TKer*:
Most of my savings sit in equity mutual funds and ETFs that track the S&P 500, which means I’m significantly exposed to the companies mentioned above. None of these companies pay me. However, literally every person I know — including myself — regularly does business with at least several of these companies in multiple ways.
I use an iPhone (AAPL) and everyone I know is either on an iPhone or an Android (GOOGL) phone. I use WhatsApp (FB) to communicate with people overseas. Amid the pandemic, I’ve been using Google Meet (GOOGL) and Microsoft Teams (MSFT) a lot more.
For work, I mostly use Chrome (GOOGL) on my MacBook Air (AAPL). I work with a lot of data, though I don’t have Office (MSFT). When someone sends me an Excel file (MSFT) I open it with Sheets (GOOGL). My website is powered by AWS (AMZN), though when there’s an outage I can’t help but be envious of those using Azure (MSFT). And when you subscribe to TKer, the GIF in the welcome email was created on GIPHY (FB).
When I publish, I share my work on LinkedIn (MSFT). Facebook (FB) is a much bigger platform for sharing content generally, but their algorithm doesn’t seem to pick up my stuff. Though lately, I’ve noticed my pieces have been surfacing in Google Search (GOOGL) results. Yahoo Search doesn’t seem to be sending me much traffic, though I’ll note that Yahoo Search is actually powered by Bing (MSFT).
In my free time, you might catch me scrolling through Instagram (FB) while I’m streaming something from Apple TV+ (AAPL) or Prime Video (AMZN). Yes, I have subscriptions to Netflix and Hulu, though I stream it all through my Apple TV (AAPL) hardware.
I have an Echo Dot (AMZN) and an Echo Show (AMZN), but I only ever use them to set timers and turn my lights on and off. I don’t use Siri (AAPL), but my sister uses it to send text messages while driving. I don’t use Nest (GOOGL) or Ring (AMZN), but my homeowner friends seem to be fans of one or the other.
For online shopping, I’m hooked on Amazon (AMZN) like everyone else. I will, however, say that Apple Pay (AAPL) and Google Pay (GOOGL) have made it a lot easier to conduct transactions on other sites.
Just to be clear, everything about me isn’t wired. I wear a mechanical watch. You won’t be able to convince me to get an Apple Watch (AAPL) or FitBit (GOOGL).
Also, I do get outside. I’ll pop in my AirPods (AAPL) and walk to the Whole Foods (AMZN) in downtown Brooklyn where I get groceries. It’s a block past the Apple Store (AAPL), but a block before the Best Buy where the new Xbox (MSFT) has been sold out for weeks – though, they do have the extremely popular Oculus 2 (FB) in stock.
When I vacation, I like secluded beaches far from any Wi-Fi or cellular signal. But even out there, I’ll see people on their Kindles (AMZN) and iPads (AAPL).
AT&T (T) used to be my wireless carrier before I switched to Verizon a few years ago. In high school, I drove a 1979 Chevy Impala station wagon (GM). I now live in NYC, where I don’t have a car.
The bottom line: While the scale of these mega-cap companies may raise eyebrows, their businesses are far more diversified than most, which means concerns about market concentration are arguably overblown.
*Back then Meta had the ticker FB. Today, it trades under META.
Related from TKer:
A quick update on earnings 📈
According to updated estimates compiled by FactSet, analysts have revised up their forecasts for S&P 500 earnings per share growth in 2023 and 2024.
The outlook for growth is modest. Nevertheless, it’s growth.
For more on earnings, read: So you're worried about an earnings recession 🙋🏻♂️ and 9 stock market charts to consider as earnings season kicks off 📊.
Reviewing the macro crosscurrents 🔀
There were a few notable data points from last week to consider:
🇺🇸 The U.S. economy grew. U.S. GDP grew at a 1.1% rate during the first three months of this year, according Bureau of Economic Analysis data released Thursday. This included personal spending growth accelerating to 3.7% during the period.
According to the Philly Fed’s State Coincident Indexes, which measures economic activity slightly differently,all 50 U.S. states saw increased economic activity in March. Over the three months through March, activity increased in 49 states and decreased in one.
For more on broad measures of the U.S. economy, read: Still waiting for that recession people have been worried about 🕰️
🛍️ Consumer spending growth cooled. According to BEA data released Friday, personal consumption expenditures increased marginally in month-over-month in March to a record annual rate of $18.1 trillion.
Card spending data suggests spending picked up in April. From Renaissance Macro Research (via Notes): “A slowdown in consumption in March appears to have unwound in April, according to the latest weekly payment card transactions data from the Bureau of Economic Analysis. For the week ending April 18, card spending advanced 15.5% with the four-week moving average running 9.4%.“
For more on consumer strength, read: Consumer finances are in remarkably good shape 💰
👍 Consumer confidence slips. From The Conference Board (via Notes): “While consumers’ relatively favorable assessment of the current business environment improved somewhat in April, their expectations fell and remain below the level which often signals a recession looming in the short-term… Consumers became more pessimistic about the outlook for both business conditions and labor markets. Compared to last month, fewer households expect business conditions to improve and more expect worsening of conditions in the next six months. They also expect fewer jobs to be available over the short term. April’s decline in consumer confidence reflects particular deterioration in expectations for consumers under 55 years of age and for households earning $50,000 and over.”
For more on how spending activity sometimes conflicts with sentiment, read: A bullish contradiction 🛍.
👍 Labor market confidence improves. From The Conference Board: “Consumers’ appraisal of the labor market improved slightly. 48.4% of consumers said jobs were “plentiful,” up slightly from 47.9%. 11.1% of consumers said jobs were “hard to get,” down slightly from 11.4% last month.“
💼 Unemployment claims decline. Initial claims for unemployment benefits fell to 230,000 during the week ending April 22, down from 246,000 the week prior. While the number remains near levels seen during periods of economic expansion, it has been creeping higher in recent months.
The backlog of unfilled core capex orders was at $266.5 billion during the month.
For more on slowing activity, read: The glass-half-full view of what could be the next recession 🥃.
📈 New home sales are up. Sales of newly built homes jumped 9.6% in March to an annualized rate of 683,000 units.
🏠 Home prices tick up. According to the S&P CoreLogic Case-Shiller index, home prices rose 0.2% month-over-month in February, ending a seven-month streak of declines. From SPDJI’s Craig Lazzara: “The results released today pre-date the disruptions in the commercial banking industry which began in early March. Although forecasts are mixed, so far the Federal Reserve seems focused on its inflation reduction targets, which suggests that interest rates may remain elevated, at least in the near-term. Mortgage financing and the prospect of economic weakness are therefore likely to remain a headwind for housing prices for at least the next several months.“
For more on the cooling housing market, read: The U.S. housing market has gone cold 🥶
💵 Labor costs are cooling. The employment cost index in the first quarter was up 4.8% from a year ago, a deceleration from the 5.1% gain in the prior quarter.
On a quarter over quarter basis, the index was up 1.2% in the first quarter, a slight uptick from the 1.1% rate in the prior quarter.
“The 1.2% increase in Q1 puts it squarely in the 1.1%-1.4% range registered over the past seven quarters, a sign the trend in labor costs has yet to convincingly ease,“ Wells Fargo economists wrote.
For more on why the Fed is concerned about high wage growth, read: The complicated mess of the markets and economy, explained 🧩
🎈 Inflation is cooling. The personal consumption expenditures (PCE) price index in March was up 4.2 from a year ago, down from the 5.1% increase in Februrary. The core PCE price index — the Federal Reserve’s preferred measure of inflation — was up 4.6% during the month after coming in at 4.7% higher in the prior month.
On a month over month basis, the core PCE price index was up 0.3%. If you annualized the rolling three-month and six-month figures, the core PCE price index was up 4.9% and 4.2%, respectively.
For more on the implications of cooling inflation, read: The bullish 'goldilocks' soft landing scenario that everyone wants 😀.
Putting it all together 🤔
Despite recent banking tumult, we continue to get evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“ And on March 22, the Fed signaled that the end of interest rate hikes is near.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tighter financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations).
At the same time, it’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
For more on why this is an unusually unfavorable environment for the stock market, read: The market beatings will continue until inflation improves 🥊 »
For a closer look at where we are and how we got here, read: The complicated mess of the markets and economy, explained 🧩 »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
At some point in the future, we’ll learn a new bull market in stocks has begun. Before we can get there, the Federal Reserve will likely have to take its foot off the neck of financial markets. If history is a guide, then the market should bottom weeks or months before we get that signal from the Fed.
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. According to their research, 29% of 791 large-cap equity funds that beat the S&P 500 in 2019. Of those funds, 75% beat the benchmark again in 2020. But only 9.1%, or 21 funds, were able to extend that outperformance streak into 2021.
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
Here’s more detail from the Philly Fed: “The coincident indexes combine four state-level indicators to summarize current economic conditions in a single statistic. The four state-level variables in each coincident index are nonfarm payroll employment, average hours worked in manufacturing by production workers, the unemployment rate, and wage and salary disbursements deflated by the consumer price index (U.S. city average). The trend for each state’s index is set to the trend of its gross domestic product (GDP), so long-term growth in the state’s index matches long-term growth in its GDP.“