Recently we have seen the S&P 500 hit an all-time high, with much of the media hailing it as the longest lasting bull market recorded for the US market.
We see the latter record as debatable given the lack of agreement about what constitutes a bear market, which is clearly required to define the starting points of previous bull markets. Yet nevertheless it's worth having a closer look at the drivers behind, and potential catalysts for, change of the current one.
The last undisputed nadir for US markets was around February 2009. Financial services firms had fallen from an almost 18 per cent weighting by market cap within the S&P 500 to just over 9 per cent, an expected drop given the total financial meltdown.
Healthcare, energy (on its way down from $140 a barrel for oil) and defensive consumer stocks saw their weighting increase to almost 45 per cent of the market, as they fell less than the financials collapsing around them. Technology stocks, also punished by broad risk-off sentiment, saw their representation in the broad market fall from 18 per cent to 16.5 per cent.
Since then, despite the fairly regular short and sharp 10-15 per cent sell-offs that were followed by swift recoveries, it has been a phenomenally profitable ride for US equity investors over the last 10 years. The index has quadrupled since then.
Inevitably, questions are being asked about whether this bull run can carry on, or whether it's now destined to crash in the not so distant future. With that in mind, we took a closer look to see how the US market has changed and what has driven such performance over the period.
The rise of tech stocks
The most intuitive way to look at the drivers of return is the changing weights of sectors within the market.
The huge increase in the barrel oil price from $60 to $140 from 2006 to 2008 saw energy companies outperform other US companies and saw the energy sector increase its share of the market to almost 16 per cent at its peak.
When the financial crisis triggered the global recession of 2008/2009, oil prices also fell back to earth. The US was the epicentre of the crisis and home to many of the largest banks in the world at the time, whose weighting fell from over 20 per cent of the index to below 10 per cent.
Even today, with US banks arguably being the only ones worldwide to have made a full recovery, their index weight has only partially recovered from this collapse.
Since 2013 however, the technology sector has been a significant driver of US stockmarket performance. It has increased its share of the total market cap by almost 7 per cent and is now north of 20 per cent of the index, the largest sector by some distance.
This probably doesn’t surprise many. We expect many of you will have used at least one of Amazon, Apple, Microsoft, Facebook, or Google’s products today.
The world and its daily habits have changed dramatically in the last 10 years, and even more since the dot-com boom with market capitalisations based on clicks rather than sales.
These companies, frequently grouped together, trade at elevated multiples of their annual earnings relative to most. These valuations are perhaps justifiable but are nowhere near as high as during the dot-com period. These firms now dominate the US market, and their valuations become the market’s valuation, which accordingly now trades more expensively than any other major developed region.
Equity markets have been underwritten by increasingly good sentiment over recent years, especially in the US which on many measures is in rude health. People remain happy to pay these prices while things are going well, rates are low, and these companies are demonstrably different from others.
Why change is afoot
But things can change a lot in ten years. Goods and features at the cutting edge in the past become normalised over time. Index providers have noticed these changes within industries and have decided to shake things up a bit. MSCI, the provider of the Global Industry Classification Standard, is about to undertake a major reclassification of the large tech companies.
Alphabet, Facebook, Netflix and Twitter will move, with others, into 'communications services', the new incarnation of telecoms. There are some other moving parts, but the main gist of the moves seems to be that these companies are no longer 'tech' companies; they sell products and services much like most other firms.
Technology will be returning to its roots as a somewhat smaller component of the market with smaller, less mature companies, while some more established sectors may now have a new ‘gorilla' in the room. Of course, these are only third-party categorisations and any management team only considering their rivals on this basis is sure of a short tenure. But investors may prove to be a more fickle bunch.
After all, as our head of manager research puts it: “Google and Facebook are just advertising companies, Amazon is just a shop”. If investors start taking that view too, their valuations, and those of the US as a whole, may converge with their new, less glamorous peers.
So, is the US stockmarket bull run sustainable? Well, unlikely if it is dependent on continued exponential growth of a small group of innovators that operate at a global scale.
As we have shown here, market leadership changes regularly and therefore positive market developments will depend much more on the sustainability of economic growth not just in the US but globally, as well as corporates’ ability to maintain their profit margins while input prices rise.
Unlike hedge funds, we are not in the business of market timing. Our role is as guardian of investment portfolios; we make sure they can generate consistent returns relative to the risk defined in their mandates.
Our experience tells us that massive businesses can, and will, fail. When valuation levels of certain sectors, regions or whole asset classes move beyond rational norms and long-term observed averages, steps need to be taken to protect portfolio values from the usually inevitable regression of those overshoots back to the norm.