Chart of the Month (March 2024)

Chart Description

• The top half of the chart above shows the three largest stocks in the United States measured by market capitalization (aggregate value of stock shares) as of 3/1/24.
• The bottom half of the chart above shows US GDP in nominal terms as of 12/31/23.
• The combined market capitalization of the top 3 stocks (Microsoft, Apple & NVIDIA) equals $7.87 trillion or 28% of US GDP.

Our Take

Despite the consensus view of strong employment, moderating inflation, and the ability of the Federal Reserve’s Open Market Committee to navigate a soft landing for the economy, we remain concerned about the unprecedented top-heaviness of the US Stock Market.  To put the current conditions in context, the top three stocks during the technology bubble of the late 1990s were Microsoft, General Electric and Cisco.  The combined market cap of those three companies in March 2000 (the tech bubble peak) was $1.43 trillion.  US GDP was $9.9 trillion on 12/31/1999.  That means that the top 3 stocks during the tech bubble were equivalent to approximately 14% of the US economy.  That period has gone down in history as one of the most overvalued periods in stock market history.  Today, using the same measure, stocks are twice as expensive with the big three representing 28% of the value of the US economy. 

We, of course, are not the only ones to point to this fact in recent months as an ominous sign for forward-looking equity returns.  The response from market bulls is almost universally, “yeah but on a price to earnings basis we are nowhere near the levels we reached in December 1999.”  We may not be there yet, but we’re getting close.  The trailing twelve-month (TTM) P/E ratio on the S&P 500 in December of 1999 was 30.68.  Today, that same measure is 24.94, roughly 23% below the level recorded during the tech boom.  Even if we’re not at the 1999 level for the S&P 500’s P/E, a ratio of almost 25 is still considered very stretched using any kind of historical reference.  Today’s P/E is ~ 35% above the average of 18.62 over the last 24 years.  Many people believe that a reasonable fair value for the stock market in normal times is somewhere closer to 16x or 17x.  The bulls are quick to remind us that this time is different because of the amazing new technology of AI (artificial intelligence).

While the Price to Earnings ratios may be below all-time highs, there is another popular valuation metric, Price to Sales, that is not.  The P/S ratio in December of 1999 was 2.59x (meaning that the value of all stocks in the S&P 500 was 259% of the value of sales generated that year.  Today, March of 2024, the P/S ratio on the S&P 500 is 2.73x, above the peak in 1999 and roughly 50% above the 20-year average of 1.81x.  One might ask why the P/S ratio provides a different picture than P/E.  Our short (and blunt) answer is that it is more difficult to fake sales than it is to cushion bottom line profits.  Think of company earnings reports as a beauty pageant.  Corporate executives intentionally craft a story every quarter to focus on all the good elements of their business and hide their blemishes.  It is rare to hear an honest accounting of a specific company’s or industry’s struggles unless the environment has gotten so bad that it can no longer be dismissed.  This is not to say that companies are doing anything illegal, although that has happened on a large scale in the past and will no doubt occur again in the future.  But, for most publicly traded companies, especially the largest, management teams have so many different levers they can pull in each quarter to make the earnings picture look “pretty.”  Again, nothing illegal or immoral, but the larger point is that we believe there is less noise in the sales figures as opposed to earnings.

Even more important than the price to earnings or price to sales ratios, is to think about the amount of value that these large companies add to consumers in the US and around the world.  Nobody would question the importance of Apple, Microsoft and NVIDIA and the impact they have on daily life, but should they really be valued at 28% of the entire US economy.  One comparison that we think is interesting is to consider how many people these companies employ.  It is commonly reported that small businesses (not publicly traded) account for roughly 60% of net new job growth in the US and employ a total of 62 million people.  There are approximately 132 million total full-time employees in the US.  Of that number, the big three market cap companies employ roughly 412k employees.  That means that these companies, whose combined stock value represents 28% of the US economy, employ only 0.32% of the employees in the economy.  That strikes us as a big problem.  Either the stocks of these companies are drastically overvalued, or a large portion of the other 99.68% of employees in the US may soon be looking for another job.  If these large companies are really generating that amount of value to daily life, then more and more of the resources, growth and jobs will be directed to those areas.  As part of the 99.68%, we are not panicking just yet. 

It also strikes us that the unprecedented top heaviness in stock values relative to actual economic value and employment presents an irreconcilable argument against the bull thesis for stocks.  It seems impossible for stock values to remain where they are and for the employment metrics to continually be as strong as what we’re told. 

While most investors in today’s market are guided by their enthusiasm for a new era of artificial intelligence and productivity, we prefer to heed the warning of Sir John Templeton, one of the greatest investors of all time with an actual track record to back it up, when he cautioned an entire generation of investors by stating, “the four most dangerous words in investing are this time is different.”  The talking heads often scoff at those of us who quote investing legends like Templeton, Buffett, and Graham, but in our view, they are taking these great words of wisdom too literally and are often guilty of short-term, surface level thinking.  Of course, “things” are different today.  Technology is different, most notably the amount and source of our daily news feeds.  There are many specific elements of daily life that are different today, but ultimately what in our view is the most important element, and what we believe Templeton really meant, was that people never change.

JPS Financial, LLC is registered as an investment adviser with the SEC. All information is believed to be current and should not be viewed as personalized investment advice. All expressions of opinion reflect the judgment of the authors on the date of publication and may change in response to market conditions. All investments and strategies have the potential for profit or loss.

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