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The S&P 500 Index Ticks Near 3,000, But I’m At 2,400

This article is more than 4 years old.

Reasoning historically, I’m at 2,400 but the market flirts with 3,000. Who’s right? I’m only 50% long, so I’m abjectly wrong-footed. Adjusted for market volatility, call me 65% invested. After all, Facebook, Alibaba, Microsoft and Citigroup can dance 4% intraday, both ways.

The sole “polite” piece of paper I own is AT&T, yielding near 5.5%, still considered an old maid’s kind of holding. But, it stands transformed by management into an entertainment conglomerate in a class with Netflix and Walt Disney. The guys at Elliott Management took notice and own 1% of AT&T’s capitalization. Just enough to make some noise like Carl Icahn.

My historical charts on interest rates, inflation, corporate earnings and profit margins no longer sing, but say market valuation stands far above precedent. Previous cycles, markets also proved hypersensitive to geopolitical risks like the Cuban missile crisis. The electro-mechanical tape then ran six hours late before the Russian freighter carrying missiles to Cuba was intercepted by U.S. Naval vessels.

Presidential interference in the business world dates back to when Jack Kennedy dissed on U.S. Steel’s Roger Blough hiking steel prices. The Street overreacted to what was construed as a clear-cut antibusiness move by the Democratic president. Joe Kennedy talked to his son who soon after relented on threats of price controls.

Today, nobody talks about price controls, but rather how to hype inflation which rests so silent. Considered by the FRB as too low for comfort. I never thought I’d ever hear the Fed plump for more inflation. Zero interest rates persist on the continent and in Japan. We’re next in line.

Rarely, if ever, does a buoyant stock market yield more than Treasuries. During market panics that take the S&P 500 down to 10 times earnings it’s possible. Currently, we’re at 18 times earnings, yielding 2%, but this beats 10-year Treasuries, even on parity with our 2-year paper.

Arriving zero interest rates here is what the stock market chooses to celebrate. After all, bulls have no earnings story to tout. Pundits are pulling in their numbers to $160 for the S&P 500 Index earnings forward 12 months. Despite all the buoyancy, disinvestment in sectors like energy and raw materials is profound. Stocks like U.S. Steel, Alcoa and Freeport-McMoRan find few takers, even after being cut in half or worse.

Once proud outfits like Schlumberger now yield over 7%, but this payout isn’t half earned. Exxon Mobil, past five years, is a dud while Halliburton trades like a ragamuffin. Carnage prevailed in basic industrials like DowDuPont and Dow Chemical while drug houses Pfizer and Johnson & Johnson disappointed.

General Electric laid a big egg, but held the number one market capitalization in 2001, worth $415 billion. Exxon Mobil was number three and Pfizer in fourth place. Lo! How the mighty have fallen! You coulda tripled your capital in Microsoft, now sporting a trillion-dollar capitalization, well deserved.

Past five years, there’s been a marked change in concentration for the S&P 500. The top five names comprised 11% yearend 2014, but now it’s closer to a 20% concentration level. Take my word for it, tech, internet and e-commerce properties like Amazon, Facebook, Microsoft and Apple show volatility at least 1.5 times the S&P 500. They are now the core of the market so we’re on a faster track. If you’re wrong on such stock picks you’ll be doubly wrong.

Scroll further down the S&P 500 list and price-earnings ratios run below 15 times earnings. I’m talking about AT&T, General Motors, even Dow Chemical. But nobody should marry such paper for life. They’re too cyclical, managements make bad deals and like General Electric do hide behind late reserve recognition for long-term liabilities. IBM, Microsoft, Citigroup and American International Group needed to replace their headmen when they floundered.

Money managers are much more sensitized to changes in earnings power metrics than historic overvaluation or undervaluation. Stock groups tend to over-shoot or under-shoot valuation as sentiment waxes and wanes. The art of money management is anticipating change at the margin rather than reacting after the facts surprise us.

Over a long cycle, five to 10 years, valuation is governed not just by earnings but the rate of inflation and bond yields. Rarely do you get what we have today, minimal interest rates and inflation that’s hard to construe in labor, new materials, even productivity. So, valuation gets a pass even with flattening earnings power coming.

We can dig up the valuation metrics that fit our thesis. For internet and e-commerce stocks it’s the Ebitda multiplier. Personally, I employ the operating cash flow metric for valuation. Then, my major holdings in Facebook, Alibaba and Microsoft seem reasonably priced.

Referring back to historical charts on interest rates and market valuation, I chose the BAA bond yield minus 10-year Treasuries. For a couple of decades this ratio hovered around 150 basis points. Pretty close to where we are currently. Valuation ranged to 15 times earnings. Anything higher put you in bubble territory like 2000. The market collapsed in 2001 to 10 times earnings and actually created a recession. It took Nasdaq over 15 years to regain its 2000 peak near 5,000. Incredible!

Currently this index shows great late foot, trading near 8,000, outdistancing all other indexes. Latest 12 months, it’s up by a third versus the 25% gain in the S&P 500. No slouching number, either. Consider AT&T is 40% above its 12-month low and making new highs. Anyone can dive into Facebook or Amazon, hoping for the moon. Past year, the analyst consensus turned up its nose on AT&T.

Big picture, I never thought I’d ever hear a Federal Reserve Board chairman fret over inflation as too low for comfort. That’s for the history books. If I ever constructed a chart on collective stupidity, FRB policy emphasis would be the vertical axis. The horizontal axis would be the S&P 500’s price-earnings ratio.

The top five market capitalizations in the S&P 500 tot up to a 16% weighting in the index. They are tech houses, internet purveyors and an e-commerce operator. Microsoft, a trillion-dollar market cap, vies with Apple and Amazon on its heels. By comparison Exxon Mobil is down the list at $296 billion. Exxon dates back to John D. Rockefeller. Present top-five haven’t been in business more than a couple of decades, excepting Microsoft.

Back in 2001, General Electric was numero uno at a $415 billion market valuation. Microsoft followed at $291 billion. American International Group in 7th place was more than cut in half since then. Citigroup, at $225 billion is now way down this list and still hasn’t recovered much 18 years later.

The market is forever the Great Humbler. In a panic, passive investors will head for the hills and in this cycle, they carry more weight. The internal structure of the market and the way people invest seem ominous. Latent irony is that if passive investors holding ETFs panic and thereby force instant liquidation by their money managers the corn won’t grow as high as an elephant’s eye, even in Oklahoma.


Sosnoff and / or his managed accounts own: Facebook, Alibaba, Microsoft, Citigroup, AT&T, Freeport-McMoRan bonds and Netflix bonds.

msosnoff@gmail.com