This guest commentary was written by Mike O'Rourke of JonesTrading
Source: Joshua Rothhaas
We have been experiencing déjà vu lately. The Nasdaq Composite topped 6,000 for the first time a couple of weeks ago due to the leadership of the Technology sector. There was a sell side call yesterday for Apple to become the first $1 Trillion company.
Given Apple’s $800 Billion market capitalization, it is a far more reasonable prediction than First Boston’s February 2000 prediction about Cisco Systems. The call was that Cisco could rise from its $450 Billion market to $1 Trillion in a couple of years. In 2000, Cisco had revenues of $19 Billion and net income of $2.7 Billion. Today, the company has revenues of $48.5 Billion and its net income is $9.8 Billion. Despite that growth, Cisco’s market capitalization today is only $171 Billion.
The fact that Technology was the leadership in 2000 and it is the leadership today is simply circumstantial. The valuations, market structure and market behavior are all different today. The Technology sector is up 17% year to date, lagging the 21% it was up in March of 2000.
One trait that is similar to 2000 is the narrow leadership. When equities blew off in 2000, the market realized that despite being very expensive in its own right, large cap Tech was very inexpensive relative to the internet names. It was that upward re-rating of large cap Tech that turned out to be the blow off top for the entire market. The Technology sector has added $685 Billion in market capitalization thus far in 2017.
Apple, Google, Facebook and Microsoft account for $450 Billion or 66% of the gain. Those are four of the 5 largest companies in the S&P 500 today. The fifth company is Amazon, a Consumer Discretionary company that would easily fit into the tech space. If you take those 5 largest S&P 500 companies, they are responsible for $548 Billion in market capitalization gains, which is equivalent to 40% of the entire S&P 500 market capitalization gain for 2017 (chart below).
As one might expect, there is an index twist on this behavior. Of course, the largest 5 companies have created the most new market cap in 2017, but they did not start the year as the largest 5 companies. Berkshire Hathaway and Exxon Mobil started the year as 4 and 5, while Amazon and Facebook were 6 and 7. Because of Berkshire Hathaway’s tightly held nature, especially for a large cap company, it has not received the full influence of the index bid in the tape.
The 18% year to date drop in WTI Crude has weighed on Exxon, regardless the company’s shares are only down 8% for 2017. Those two facts, in combination with strong sponsorship, have allowed Amazon and Facebook to join their Tech compatriots as the narrow Fab 5 leadership supporting this tape. These 5 companies represent 13.4% of the S&P 500’s market capitalization (chart below). The big continue to get bigger in a tape where new Dollars, and lots of old ones, coming into the market are indexed. This complacent blind buying simply reinforces bad behavior.
Last week, we highlighted the massive shorting occurring in Volatility related ETNs. The only time the Vix has ever closed lower was around Christmas in 1993. This means it is the largest volatility short position at the lowest level of volatility. If there has ever been a time to heed Hyman Minsky’s maxim “Stability breeds instability,” this should be it.
This is a Hedgeye Guest Contributor research note written by Michael O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.