We were about to publish this commentary on the American stock market sectors when a news item about the healthcare sector crossed our screen. So we have decided to lead with it and then go to the stock market. Here is a fresh report about behavior and its consequences at a medical school in Gainesville, Florida: "18 in UF Health anesthesiology contract virus after party," https://www.gainesville.com/news/20200727/18-uf-health-anesthesiologists-contract-virus-after-party. Readers can judge for themselves. Consider the following questions. Should the school investigate the party? If there was a party, should the school congratulate the medical students for achieving herd immunity at this party and offer them a cum laude degree? Expel them? Suspend them? Assign a research paper on epidemiology? I plan to share reader responses in a follow-up. If you reply with an email, please indicate whether you wish to remain anonymous or to use your name. I cannot use your identity without permission.
Now let’s segue to the US stock market.
We thank DataTrek for permission to quote their research from their July 23, 2020, daily. DataTrek’s Morning Briefing” is essential reading for me. It’s available by subscription only, but readers can sign up for a free trial here: http://datatrekresearch.com/?inf_contact_key=361804e086110e1dd546ab955846c9bf.
DataTrek opened with this summary:
"Markets: Big Tech is now 38% of the S&P 500. The only other sector to ever get close to this percentage is Energy: 29% in December 1980. We have a complete history of every other S&P sector’s peak weight below, but the common factor is they all had a big macro story to match their outsized allocation. Can Big Tech ever be 50% of the S&P? If Energy was once 29%, and narratives matter, then the answer is very likely ‘Yes’.”
Kotok note: I remember the 29% peak, which occurred in early 1979 when the Shah of Iran fell from power and was replaced with the current government of religious zealots, which is anti-West. A few years earlier, in October 1973, the Yom Kippur War started when a coalition of Arab states led by Egypt and Syria launched a joint surprise attack on Israeli positions in the Sinai Peninsula and the Golan Heights. After several days, Israel halted the Egyptian offensive and then launched a counter-offensive deep into Syria. Israel had been attacked on the holiest day in the Jewish calendar; hence the nickname for the fight. (“Yom Kippur War,” Wikipedia, https://en.wikipedia.org/wiki/Yom_Kippur_War). The price of oil subsequently quadrupled, from $3 to about $12 a barrel, and by the end of the decade the price stood at $30. Also note that the Energy sector weight in the S&P 500 before the Egyptian-Syrian attack was under 6%.
Given this history, it should be clear that DataTrek’s discussion of relative sector weights is critical analysis for any thoughtful investor in US stocks. If you’re in the wrong (declining relative weight) sectors, your portfolio is swimming against the tide. If you’re in those sectors that have rising relative weight, the tide is bearing you along.
DataTrek then gets into the weeds of sector weighting peaks. The following is an extended excerpt:
How much more of the S&P 500 can Big Tech swallow? We’re not just talking about the Tech sector here, but names like Alphabet/Google and Facebook (in Communication Services) as well as Amazon (in Consumer Discretionary). Once Tesla goes into the S&P, the same question will apply to it.
Three thoughts on this:
#1: The current state of play and a bit of history:
• Technology as a sector is 27.0% of the S&P 500 today. Amazon is 4.9%, Google is 3.4%, and Facebook 2.2%.
• This sums to 37.5%. One could add other Tech-ish names like Netflix (0.8% of the S&P), but in truth there’s not many other companies in the index one might need to reclassify to have a clean all-in Tech weighting.
• Today’s 37.5% weighting compares to 32.5% in March 2000, at the peak of the dot com bubble. Amazon was not in the S&P 500 at the time, and neither Google nor Facebook were even public.
Takeaway: On an apples-to-apples basis Tech’s weighting in the S&P 500 is now at a record that exceeds even March 2000. As we’ve written, this is entirely understandable: Apple, Microsoft, and today’s other Big Tech companies enjoy much higher levels of absolute profitability and return on capital than the flotsam that populated the Tech sector during the dot com bubble. Still, in our next point you’ll see that 38% isn’t just a record for Tech – it is an all-time record for any industry weight.
#2: Other sectors have had notable peaks in their S&P 500 weightings; here’s what we can learn from them. Sectors don’t always stay exactly the same, so we will note any changes that might inform this discussion:
Consumer Discretionary: peak weight in June 1986 at 16.9%. Current weight: 11.1% but take out Amazon and it’s just 6.2%. Even adding back Disney (0.8% weight), Netflix (0.8%) and other names recently reclassified to Communication Services doesn’t get you close to the 1986 high.
Comment: demographic and economic/financial asset tailwinds made the 1980s the best time for Consumer Discretionary company profitability and return on capital.
Consumer Staples: peak weight in December 1991 at 17.2%. Current weight: 7.0%.
Comment: the early 1990s was ‘peak brand power,’ with consumer packaged goods companies seeming to have infinite pricing power and significant international growth potential as well. ‘Marlboro Friday,’ when Philip Morris cut prices by 20% in response to generic competition, was in April 1993 and the group really hasn’t been the same since.
Energy: peak weight in December 1980 at 29.0%. Current weight 2.7%.
Comment: Energy’s star had been rising since the 1973 Saudi oil embargo first spiked commodity prices, but the 1979 Iranian revolution was the catalyst that took the sector from 19.2% in March 1979 to that 29.0% peak just 7 quarters later.
Financials: peak weight in December 2006 at 22.3%. Current weight (including Real Estate, spun off in September 2016) 12.7%.
Comment: Financials peaked in December 2006… Not much of a surprise.
Health Care: peak weight in March 2003 at 16.0%. Current weight 14.7%.
Comment: peak Health Care coincided with the investors looking for safe havens during Gulf War II, and despite many medical advances since then the group has not been able to take incremental market cap from other sectors.
Industrials: peak weight in March 1986 at 15.6%. Current weight 8.0%.
Comment: Jack Welch was at the height of his powers at a still-industrial GE in 1986, and defense companies (also Industrials) benefited from dramatically increased government spending through the 1980s.
DataTrek’s Takeaway from these examples: secular peak sector weights always come with a story that goes beyond industry-level fundamentals. It might be geopolitics (Energy), or risk aversion (Health Care) or the illusion of endless pricing power and international growth (Staples), but there’s always a big narrative that goes with big valuations.
#3: In order for Big Tech to keep outperforming from here, it has to take more relative market cap from other sectors. A few ideas on that:
• Energy, Materials and Real Estate total 8.0% of the S&P 500 and each in its own way faces fundamental headwinds in a post-COVID recovery. None of these sectors are going away, but their collective S&P 500 weighting in a year could just as easily be 6% as 10%.
Bottom line: a longer, choppier global economic recovery may see capital further leave traditional cyclical plays and move more to “growth cyclicals” like Tech.
• Consumer Discretionary weighting has been stable at 10-11% since the start of 2019, but Amazon has taken 2.5 points of sector market cap at the collective expense of every other name in the group. It is now 25% of the entire sector’s value.
Comment: this is the easiest place to see where Tech can continue to gain market cap.
• Health Care (14.7%) and Financials (10.0%) are the 2 largest S&P sectors with no real Tech exposure. Over the long term, both are certainly in Tech’s crosshairs: “medtech” and “fintech” are established subindustries with their own venture capital funding and Big tech corporate planning departments.
Comment: to be ultra-bullish on Tech’s long-term promise – that it can one day be 50% of the S&P 500, for example – one has to tell a credible story about how it takes profits from these two industries. Nothing else in the 500 is big enough to really matter anymore.
Summing up: being market historians at heart, we keep coming back to that 29% peak Energy weight in 1980 because it’s the only non-Tech sector to ever get close to Tech’s current +30% weight. If prosaic oil companies were once 29% of the S&P, why can’t innovative Tech one day be 50% of the index? Yes, at that point I think we’d all agree Tech would be in a bubble just like Energy was in 1980. But we’re not there yet….
[End excerpt]
We thank DataTrek for permission to share this sector analysis and the discourse on relative weights among the S&P 500 sectors.
Note that Cumberland manages US stock market ETF strategies in several different ways. We use sector ETFs as part of those strategies. We file a quarterly public report on our ETF holdings. We can also send anyone interested the marketing materials on those ETF strategies. It may help to have a conversation with us prior to our sending all of them.
David R. Kotok
Chairman of the Board & Chief Investment Officer
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