The 'Real' S&P 500 And Why The Current Rally Makes Sense

Many casual observers and professionals alike have been confounded by the incredible stock market rally over the past couple of months. As this article is being written the S&P 500 is above 3,000, which represents a rally off the March 23 bottom of close to 40%.

With the unemployment rate at 15% (likely set to increase further next month), GDP poised to drop at a staggering annualized rate of more than 30% during the current quarter, and an ever-increasing tide of small business closures and bankruptcies; it almost seems impossible for the stock market to have largely shrugged off the pandemic. The S&P 500 is only down 6.0% in 2020 and up 8.5% over the past full year. 

Despite this surface data screaming ‘the stock market is crazy’, ‘this rally is doomed’, and ‘we are bound to crash again’, investors have to dig into information that lies beneath this dark veneer to understand why S&P 500 3,000 makes perfect sense. 

There are two main areas to investigate; current economics/government programs and the current sector make up of the S&P 500. 

Economics/Government Stimulus: 

• Despite current headline unemployment of 14.7%, it was self-reported that just under 90% of these newly unemployed view their status as temporary. This means they believe they will return to their original job within 6 months. If this is the case, the real ‘permanent’ unemployment rate might be closer to 5.5% to 6.5%. It is likely this will increase as we move into May/June, but it is tough to directly compare current headline numbers to past unemployment rates, because of the unique ‘lockdown’ impact.
• Regardless if the unemployment is temporary or long term, it is estimated that as astonishing 68% of those currently receiving unemployment (with the additional $600/week bonus) are actually earning more than they were while employed.
• The FED unleashed unprecedented stimulus in the form of a return to 0% short term interest rates along with supporting a sub 1% 10-Year Treasury yield. In addition, the FED is purchasing select municipal/mortgage securities, and for the first time in history purchasing corporate bond ETFs. Potential fund targets could include iShares Investment Grade Corporate Bond Fund LQD and iShares High Yield Corporate Bond Fund HYG. 
• Congress and the Administration also unleashed enormous stimulus in the form of the PPP program supporting small businesses across the country. This is a combination of grants and/or ultra-low interest loans. There has also been more focused help to larger companies in extremely hard-hit industries such as the airlines. 

All the above programs translate to somewhere between $5-7 trillion injected into all levels of the economy; individuals, small businesses, large businesses, and direct bond/security purchases. This is, by far, the largest financial market stimulus that has ever been implemented in the history of the United States and its impact is undeniable. 

Current ‘True’ Sector Composition of the S&P 500:

• Looking past the ‘official’ sector makeup of the S&P 500 that was altered about 2 years, we see a very different sector composition of the index when you review the index company by company 
• The official stated percentage of the S&P 500 within technology is 26%; however in reality this is much higher when companies such as Amazon.com Inc AMZN, Facebook Inc FB, and Alphabet Inc GOOGL GOOG are counted as technology companies. 
• Per our firm’s research we feel the actual percentage of the S&P 500 made up of ‘technology’ companies is in the 45% to 50% range. 
• In addition to this allocation, there is an additional 15% in healthcare, 3% in utilities, and 7% in consumer staples. These are sectors that are historically defensive and through this recession, like technology, were largely spared any major negative operational impact. 
• When these three ‘traditional’ defensive sectors and the broad technology sector are combined, they represent about 70% to 75% of the entire S&P 500.

This is certainly not your fathers’ S&P 500 where a large percentage of the index was made up of financials, energy, materials, transports, and industrials. These were cyclical and very recession sensitive. The current 70% to 75% ‘defensive/technology’ composition of the S&P 500 has changed the index immensely and altered how it reacts to a low interest-rate/deflationary recession. 

The story could be quite different in a higher interest rate/inflationary slowdown, as that would hurt technology significantly; but we are not in that position. It is important to note the ‘other 25%’ of the stock market not in the ‘majority’ sectors is still down significantly for the year and more in line with traditional recessionary performance. There are many stocks in the energy, financial, industrial, and material sectors still down 25% to 50%. 

As I stated prior, this stock market rally has made little sense to most investors, and in some cases even angered some. However, once you take full stock of both the immense amount of stimulus/support the government has pumped into the economy and the current composition of the S&P 500 (75% technology and defensive stocks), the rationalization of the 40% rally off the lows is in plain sight. 

As of this writing we are flirting with S&P 500 3,050; and from this point forward the ‘easy money’ has probably been made. Any further increases might have to wait for a more ‘complete’ reopening, further positive progress on vaccines/ treatments, and more clarity in terms of China, and the election. The market and our firm are now confident the worst has passed. 

Eric Mancini, CFA, CFP, CAIA is the director of investment research and a wealth advisor with Traphagen Financial Group (www.tfgllc.com). TFG is an independent fee-only fiduciary RIA located in northern NJ.