Champagne for Equities. Ramen for Income
As valuations continue to soar despite a cooling economy, those who own assets are feeling great but for those with lower income, confidence is falling fast.
As of Wednesday’s close, the broader S&P 1500 equal-weighted index had not reached a new high in 660 days, while bulls outnumbered bears 3x, at 60.3% versus 17.9%, according to the latest Investors Intelligence poll.
Nvidia, Microsoft, and Apple account for around 50% of the S&P 500's gains YTD and nearly all of the gains in Q2. While valuations aren’t a good timing metric, they are useful for evaluating forward risk versus potential reward.
Apple is now trading at its highest price-to-sales (TTM) ratio ever, nearly 9x. Microsoft is at its highest since 2001, over 14x, and Nvidia is at nearly 40x.
To put that into perspective, let me guide you to a 2002 Bloomberg interview with Scott McNealy, the CEO of Sun Microsystems.
At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?
Let me repeat: Nvidia is at 40 times its revenues!
The latest Conference Board report on consumer confidence saw the key “expectations” component drop to 73.0 from 74.9, but the big story is the split between high and low-income levels. The confidence index for those with earnings over $125k rose to a 5-month high of 111.9 in June, while the index for those with income in the $25k to $75k range dropped nearly 10 points to the lowest level since June 2022. The biggest takeaway is that 48.4% were bullish on equities, which is near the top of the range over the past seven years, while those who are bearish are at less than half that level at 23.5%, the lowest since February 2020.
Just as with valuations, sentiment is not a good timing indicator, but it is helpful for likely forward returns. When sentiment is exceptionally high
The S&P 500 was flat one year after the first green star in November 2014. It was down over 7% following the second green star in January 2018 and up 5% for the third from April 2021.
One of the more unique attributes of the market this year is the lack of breadth - hat tip to Bespoke Investment Group for this chart.
Through Wednesday’s close, the S&P 500’s price moved in the opposite direction of its daily breadth readings 23% of all trading days since the start of the year. Going back over 30 years to 1990, that is tied for the most divergence ever. The only other year where there were as many was in 1995, and the only other year that was even close was 2000. From July 1990 to July 1991 the S&P 500 rose 24% while from July 2000 to July 2001 the S&P fell 15.8%. While divergence often sounds alarm bells, it doesn’t have a great predictive track record.