View from the Observation Deck 
 
On Friday May 5, 2023, the Director-General of the World Health Organization (WHO) declared that the coronavirus 2019 disease (COVID-19) was no longer a public health emergency of international concern. We started this blog series on 5/7/20 (click here to view that original post), and have posted 10 updates (not including this one) since then. Given the WHO’s update to the pandemic, we thought it would be relevant to provide a recent snapshot of global equity performance. Today's blog post features the total return performance figures for the major global stock indices over four specific periods since the start of 2020. There is quite a lot of data to review here, so let’s break it down and discuss a few relevant talking points.

The first column in the table above indicates that, with the exception of the S&P SmallCap 600 Index, U.S. equities were outperforming their foreign counterparts prior to the peak in the S&P 500 Index on 2/19/20. Due largely to the onset of coronavirus (COVID-19), a major shift in sentiment occurred after the close of trading on 2/19/20.

The second column captures the depth of the sell-off in the stock market in the U.S. and abroad. Notably, the S&P 500 Index crossed over into bear market territory (a 20% or more price decline from the most recent high) at the close of trading on 3/12/20. It only took 16 trading days, the fastest path to a bear market ever. The sell-off ceased on 3/23/20.

The third column shows the rebound in progress. The S&P 500 Index was highly volatile during this time frame, recovering from its previous bear market to set its all-time high on 1/3/22, then falling 25.43% on a price-only basis to a new bottom on 10/12/22. As reflected by the year-to-date returns in the table, the index has since bounced back from that low, but remains 13.57% below its all-time high as of 5/23/23. U.S. equities significantly outperformed their foreign counterparts over the time frame in the column.

The fourth column reflects the year-to-date (YTD) total returns through 5/23/23. As reflected by the table, the NASDAQ 100 has far outpaced any of the other indices in the table so far this year.

The fifth column reflects total returns since the start of 2020. The U.S. equity indices are dominating their foreign counterparts over the period.

Takeaway: One of the more obvious takeaways from today’s table is just how resilient the global equity markets have proven to be in the face of uncertainty. Between the onset of COVID-19, surging global inflation, the tightening of monetary policy, Russia’s invasion of Ukraine, and the more recent banking turmoil, to name a few, companies around the globe have overcome a myriad of obstacles to growth. From 12/31/19-5/23/23, the U.S. dollar rose by 7.36% against a basket of major currencies, as measured by the U.S. Dollar Index (DXY), according to Bloomberg (not in table). As indicated by the returns in the table, the increase in the U.S. dollar has proven to be a drag on the performance of unhedged foreign securities held by U.S. investors over the period. Even so, with the exception of Emerging Markets and Latin America, equities have enjoyed positive total returns over the period that began on 12/31/19.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 stocks used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is a capitalization-weighted index that tracks U.S. stocks with a small market capitalization. The Nasdaq 100 Index includes 100 of the largest domestic and non-financial companies listed on The Nasdaq Stock Market based on market capitalization. The MSCI BIC Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of Brazil, India and China. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Europe Index is a free-float weighted index designed to measure the equity market performance of the developed markets in Europe. The MSCI Emerging Markets Latin America Index is a free-float weighted index that captures large and mid-cap representation across five emerging markets in Latin America. The MSCI World (ex U.S.) Index is a free-float weighted index designed to measure the equity market performance of developed markets. The U.S. Dollar Index (DXY) indicates the general international value of the dollar relative to a basket of major world currencies.

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The next blog post will occur on Tuesday, June 13.

View from the Observation Deck

Today's blog post compares the performance of energy-related stocks to the broader market, as measured by the S&P 500 Index, over an extended period. We target energy and utility stocks for a few reasons. First, most developed and developing economies are dependent on oil/gasoline, natural gas, and electricity for their growth, and prices of those commodities can influence valuations of the companies involved in those sectors. Second, as evidenced by the $7,500 federal tax credit for Plug-in Electric and Fuel Cell Electric Vehicles, there is a strong push to get consumers to opt for electric and electric hybrid alternatives (EVs) over traditional internal combustion engine vehicles moving forward. As demand for EVs grows, it is possible that Utilities (electrical grid) could see increased demand when compared to Energy (oil and gasoline).

As indicated in the table, the Energy and Utilities Indices posted negative total returns over the 1-year and YTD periods, respectively. As expected, the 50/50 blend of the two sectors also posted negative total returns over the same time frames. The S&P 500 Index fared comparatively well, posting positive total returns across each of the time frames in today’s table.

The recent sell-off in energy-related stocks is reflected in the comparatively poor returns displayed in today’s table. Broadly speaking, the Energy Index outperformed the S&P 500 Index in just one of the eight time frames referenced above. Likewise, the Utilities Index and the 50/50 blend outperformed the S&P 500 Index in just one time frame each. Notably, Utilities outperformed Energy in six of the eight time frames above. By contrast, when we last updated this post on 9/15/22 (Click here to view that blog entry), Utilities had outperformed the S&P 500 Index in four of the eight periods, Energy had outperformed the S&P 500 Index in three of the periods, and the 50/50 blend enjoyed outperformance in five of the eight time frames. 

The Price to Earnings (P/E) multiples for all three indices in today’s table sit below their 20-year averages.

As of 5/22/23, the 2023 year-end P/E ratios for the S&P 500, Energy, and Utilities Indices stood at 19.07, 10.38, and 17.51, respectively. By contrast, the 20-year average P/E ratios for those same indices stood at 18.31, 34.14, and 16.58, respectively, through 5/22/23. Energy and Utilities stocks had a combined weighting of approximately 7.05% in the S&P 500 Index, according to data from Bloomberg. The P/E ratios for the S&P 500 Index, Energy Index, and the Utilities Index reflect year-over-year earnings growth estimates for 2023 of -2.49%, -27.4%, and 7.7%, respectively, as of 5/19/23.

Takeaway: With total returns of 65.43% and 1.56%, respectively, Energy and Utilities were the only S&P 500 Index sectors to post positive total returns in 2022 (not in table). Since then, they have underperformed the broader S&P 500 Index by a significant margin. Notably, the 2023 expected year-over-year earnings growth rate for the Energy Index stood at -27.4%, while earnings for the Utilities Index are expected to grow 7.7%. We are not surprised to see the earnings growth for Utilities companies remain positive, even with the threat of a recession. Most households will keep using their lights, air conditioning, stoves, and furnaces even if budgets are stretched. Energy stocks, on the other hand, tend to be more volatile. The potential for lower economic activity means fewer deliveries, trips to the store, and travel, which can have a negative effect on the earnings of Energy companies.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P 500 Energy Index is a capitalization-weighted index comprised of 21 companies spanning five subsectors in the energy sector. The S&P 500 Utilities Index is a capitalization-weighted index comprised of 29 companies spanning five subsectors in the utilities sector. 

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View from the Observation Deck 
We like to update today’s table on a regular basis to show the effect monetary policy could be having on government bond yields. As many investors are aware, global central banks have been tightening monetary policy as they battle inflation, leading to increased yields. In the U.S., for example, the Federal Reserve increased the federal funds rate from 0.50%, where it stood on 4/29/22, to 5.25% as of 5/3/23. Despite these higher policy rates, headline inflation remains elevated in nine of the ten countries listed in today’s table (China being the exception).

The yield curve between the 10-Year Treasury Note (T-note) and the 2-Year T-note remains inverted in the U.S.

Historically, an inverted yield curve has been a fairly accurate indicator of an impending economic recession. Data from the Federal Reserve Bank of San Francisco shows that an inverted yield curve has been a precursor to each of the last 10 economic recessions in the U.S. since 1955. As of 5/17/23, the yield on the 2-year T-note sits 59 basis points (bps) above the yield on the 10-year T-note (see table).

Negative real yields on government bond issues remain the rule rather than the exception.

As shown in the columns marked “12-Month Change (Basis Points)”, yields on most of the government bonds in today’s table reflect increases over the past 12-months. That said, even though policy rates and yields rose over the period, the 10-year bonds of nine of the ten countries represented in today’s table reflect negative real yields (yield minus inflation). As of 5/17/23, China is the only country that does not have a negative real yield. Click here to view our post from 5/16/23, where we wrote about the real yield on the 10-year T-note in more detail.

Takeaway: Despite the tighter monetary policies enacted by central banks around the world, inflation remains stubbornly high. All but one of the countries in today’s table has a headline inflation reading that is above their stated target rate (China being the exception). The impact of higher interest rates on bond yields has been notable, with most of the countries in today’s table experiencing year-over-year (y-o-y) yield growth, and many of them experiencing y-o-y yield growth of 100 bps or more. That said, the effects of inflation are reflected in the real yields of these government issues. As mentioned above, real yields are negative for nine of the ten countries represented in the table.

This chart is for illustrative purposes only and not indicative of any actual investment.

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View from the Observation Deck  

We like to update this table from time to time, to keep tabs on the impact the recent interest rate spikes may be having on the fixed income market. The real rate of return on a bond is calculated by subtracting the most recent inflation rate, such as the Consumer Price Index (CPI), from the bond's current yield. The higher the real rate the better for investors. At a base level, in order to maintain one's purchasing power, bond investors have sought to generate a yield that at least outpaces the rate of inflation over time.

The yield on the benchmark 10-year T-note was 3.47% (3.5% rounded) on 5/12/23, below the 4.9% trailing 12-month rate on the CPI in April 2023. That equates to a real rate of -1.4%, which obviously does not outpace inflation.

For comparative purposes, from 5/12/93 through 5/12/23 (30 years), the average yield on the 10-year T-note was 3.86% (3.9% rounded), while the average rate on the CPI stood at 2.5% (4/30/93-4/30/23), according to Bloomberg. Those figures translate into an average real rate of return of 1.4%, far more attractive than currently available real rates. For continued comparison, the S&P 500 Index experienced an average annual total return of 9.8% for the 30-year period ended 5/12/23.

As of 5/12/23, the federal funds target rate (upper bound) stood at 5.25%, up from 4.50% at the start of 2023, and significantly higher than when it stood at 0.25% at the start of 2022.

As the table shows, the CPI stood at 4.9% at the end of April 2023, significantly lower than its most recent peak of 9.1% in June 2022. A decrease in the growth rate of the CPI could be an indication that tighter monetary policy is having the desired effect on rising prices. That being said, the CPI remains well above its 30-year average rate of 2.5% (addressed above), and even further from the goal rate of 2.0% that the Federal Reserve (“Fed”) is aiming to achieve. A data point we find interesting is that the federal funds target rate (upper bound) averaged 2.48% for the 30-year period ended 4/28/23, almost exactly in-line with the 30-year average rate of inflation. The passage of time will reveal if the Fed realizes their goal rate of 2% inflation without having to increase the federal funds rate further.

Takeaway: Many pundits would argue that the recent slowdown in the rate of inflation, as measured by the CPI, is likely the result of the Fed’s shift towards tighter monetary policy. That same policy shift has ushered in a period of higher yields on the 10-year T-note (see table). Unfortunately for bond investors, higher interest rates have been unable to overcome the impact of inflation on real yields over the past several years. As today’s table reveals, the real yield on the 10-year T-note has been negative at the end of the last four consecutive years and remains negative today. While inflation is not the only metric the Fed looks to for guidance as it sets its target rate, it has openly stated that one of its goals is to reduce the CPI to 2.0% or lower. There were eight observations in today’s table where the CPI was 2.0% or lower. Real yields were positive in seven of those eight year-end snapshots.

This chart is for illustrative purposes only and not indicative of any actual investment. 

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View from the Observation Deck  

In our last blog post (Click here for "Recession? Don't Ask The Equity Markets..." we provided a geographic breakdown of the revenue streams of the 500 largest publicly traded U.S. companies. While there are a myriad of factors that affect market performance and returns, we were curious as to what the data would reveal if we sorted the 500 companies from our previous post by sector. In the chart above, we show the 500 largest publicly traded U.S. companies (by market cap) categorized by sector and then ranked by the percentage of their revenue that was generated outside of North America.

Information Technology, Materials, Real Estate, Energy, and Industrials have the highest exposure to revenue from outside of North America (see chart).

For the sake of transparency, it should be noted that just two of the 500 companies represented in today’s chart are classified as real estate, and the results should be viewed through that lens. That said, the chart reveals that a staggering 57.5% of the revenue generated by technology stocks is derived from outside of North America. We find this fact interesting because technology stocks, as measured by the S&P 500 Information Technology Index, have posted the highest total return of the eleven sectors that comprise the S&P 500 Index between 9/30/22 and 5/8/23 (the same time frame used in the previous post).

All eleven sectors that comprise the S&P 500 Index posted positive total returns between 9/30/2022 and 5/8/23.

The three top performing sectors and their total returns over the time frame are as follows: Information Technology (28.94%); Communication Services (22.03%); and Industrials (20.85%). The three worst performing sectors over the period and their total returns were: Consumer Discretionary (3.21%); Real Estate (5.20%); and Utilities (6.85%). For comparison, the S&P 500 posted a total return of 16.54% over the time frame. 

Takeaway: As the name of our blog suggests, we believe that cash flows are the lifeblood of corporations. In our view, publicly traded U.S. companies with diverse geographic cash flows may be able to weather economic difficulty more readily that those without. According to projections from the IMF, GDP growth rates in emerging and developing economies are forecast to slow at a lower rate than the U.S. Additionally, many pundits are forecasting a recession to occur in the U.S. at some point this year. In light of these projections, we believe that investors may benefit from exposure to sectors that contain companies with geographically diverse revenue streams.

This chart is for illustrative purposes only and not indicative of any actual investment. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector.

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View from the Observation Deck

If the U.S. is heading towards an economic recession, the equity markets don’t appear to have noticed, in our opinion. From 9/30/22 to 5/8/23, the S&P 500 Index (“Index”) experienced a total return of 16.54%, according to data from Bloomberg. All eleven of the sectors that comprise the Index are positive over the period. Information Technology, Communication Services, and Industrials have each posted total returns in excess of 20%. In several of our recent posts (Sector Performance Via Market Cap and The Only Constant Is Change to name two) we offered insights as to why we think this may be occurring. In today’s post we provide a geographic breakdown of the revenues of the top 500 public U.S. companies by market cap to see if the data provides further context.

The 100 largest public U.S. corporations receive a significant percentage of their revenues from outside of North America (see charts above).

Perhaps unsurprisingly, the bigger companies in today’s chart account for a larger portion of overall revenues. The top 20% of companies by size generate 55.1% of the revenues of all the companies represented. Interestingly, 31.4% of the revenues generated by the top 20% come from outside North America.

In a break from long-term trends, international equities have significantly outperformed their U.S. counterparts in recent months.

International companies, as measured by the MSCI World (ex U.S.) Index, posted average annual total returns of 5.25% over the 10-year period ended 5/8/23. For comparison, the average annual total returns of U.S. stocks, as measured by the S&P 500 Index were 11.85% over the same period. Recently, the tables appear to have turned. From 9/30/22 to 5/8/23, the MSCI World (ex U.S.) Index posted a total return of 30.36% compared to the S&P 500 Index’s 16.54%.

Global GDP growth may not decline as much as U.S. GDP growth in 2023.

In the April edition of the World Economic Outlook, the International Monetary Fund (IMF) projected that the GDP growth in advanced economies is projected to fall from 2.7% in 2022 to 1.3% in 2023. The IMF forecasts that the GDP growth rate for Emerging Market and Developing Economies could fall from 4.0% in 2022, to 3.9% in 2023. On a nation-state level, U.S. GDP is projected to fall from 2.1% in 2022 to 1.6% in 2023. For comparison, boosted by the recent re-opening from COVID lockdowns, China’s GDP is expected to grow from 3.0% in 2022 to 5.2% in 2023.

Takeaway: From 9/30/22 to 5/8/23, international stocks, as measured by the MSCI World (ex U.S.) Index, significantly outperformed their U.S. counterparts (as measured by the S&P 500 Index). As today’s charts show, the largest public U.S. companies receive a significant portion of their revenues from international sources. In our view, this international revenue stream may help explain the outperformance large cap stocks have enjoyed when compared to their mid and small-cap peers. Furthermore, we think international revenue could provide ballast to larger U.S. companies moving forward. According to projections from the IMF, GDP growth rates in emerging and developing economies are not forecast to slow at the same rate as the U.S. China, for example, will benefit from strong comparisons this year as the country re-opens from COVID lockdowns that stretched into the beginning of 2023. That said, Brian Wesbury, Chief Economist at First Trust Portfolios, LP continues to expect an economic recession to hit the U.S. economy at some point this year, and the IMF notes that risks to their outlook are squarely to the downside. Should recession occur, investors may benefit from the geographically diverse revenue streams that larger public U.S. companies offer, in our opinion.

This chart is for illustrative purposes only and not indicative of any actual investment. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The MSCI ACWI ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets countries (excluding the US) and 24 Emerging Markets countries.

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View from the Observation Deck  

At one of my recent talks, I asked whether the audience believed the U.S. dollar was stronger or weaker today than it was 25 years ago. The overwhelming response was that the dollar had weakened substantially when compared to its peers over that time frame. Predicting the direction of the dollar, or any currency, can be a daunting task, even for professionals who specialize in it. One thing we can provide is some context. Today’s chart serves to do just that.

A quick word about the index (DXY) used in today’s chart.

The DXY Currency Index is a measure of the value of the U.S. dollar against a weighted basket of six currencies used by U.S. trade partners. The basket is comprised of the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and the Swiss Franc.

The index rose by 1.95% over the 25-year period ended 4/28/23.

As can be seen the chart, while the dollar has experienced significant volatility over the past 25 years, its closing price of 101.66 on 4/28/23 was 1.95% higher than where it stood on 4/30/98, when it closed at 99.71.

The U.S. dollar exhibited significant price swings throughout the period represented in the chart.

The high for the 25-year period was $120.90 which was set on 7/5/01. The low for the period occurred on 4/22/08 when the dollar bottomed at $71.33. In the past 12 months, the U.S. Dollar Index ranged from as low as 101.01 (4/13/23) to as high as 114.11 (9/27/22). Additionally, the U.S. Dollar Index has closed trading above the 100 mark in every trading session since 4/13/22, according to data from Bloomberg. The relative value of the dollar has been boosted by the Federal Reserve’s (“Fed”) aggressive rate hikes and forward guidance as well as foreign investors using the dollar as a safe haven over the past year as the war between Russia and Ukraine raged on, in our opinion.

Takeaway: Regardless of popular perception, the U.S. dollar strengthened when compared to a basket of its peers over the past 25 years. In our view, the relative value of the U.S. dollar has been boosted by the Fed’s rate hikes, the continuation of its quantitative tightening program to pare down the assets on its balance sheet (at a pace of up to $95 billion per month), and foreign investors using the dollar as a safe haven amidst geopolitical turmoil. Additionally, the Fed’s decision to increase interest rates an additional 25 basis points on 5/3/23 will likely provide ballast to the dollar, in our opinion.

This chart is for illustrative purposes only and not indicative of any actual investment. Investors cannot invest directly in an index. The U.S. Dollar Index (DXY) indicates the general international value of the dollar relative to a basket of major world currencies.

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View from the Observation Deck  

Covered call strategies tend to be most beneficial when the stock market posts negative returns, or when returns range from 0%-10%.

The S&P 500 Index posted negative total returns just three times in the table above. The CBOE BuyWrite Index outperformed the S&P 500 Index in two of those three years (missing the hat trick 3/3 by 0.39 percentage points in 2018). For comparison, there are four years in the table where the S&P 500 Index posted returns between 0% and 10%. During those time periods, the CBOE BuyWrite Index outperformed the S&P 500 Index in three of the four years (missing the fourth year by 0.66 percentage points in 2005). Year-to-date through 4/28, the S&P 500 Index has outperformed the CBOE BuyWrite Index by 1.99 percentage points.

Covered call options can generate an attractive income stream, but they can also cap the potential for capital appreciation.

There were 12 years in the table where the S&P 500 Index posted total returns of 10% or more. The CBOE BuyWrite Index underperformed the S&P 500 in every one of them.

Takeaway: Covered call strategies offer a unique alternative to the S&P 500 Index. The income they provide has generally led to outperformance during negative or moderately positive periods. This income comes at a potential cost, however, as returns can be capped during periods where the market is performing exceedingly well. As the table shows, the CBOE BuyWrite Index outperformed the S&P 500 Index in five of the seven periods where the S&P 500 Index posted annualized total returns of 10% or less. For comparison, the CBOE BuyWrite Index underperformed the S&P 500 Index in all 12 of the years where the S&P 500 Index posted returns of more than 10%.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The CBOE S&P 500 BuyWrite Index (BXM) is designed to track a hypothetical buy-write strategy on the S&P 500. It is a passive total return index based on (1) buying an S&P 500 stock index portfolio, and (2) "writing" (or selling) the near-term S&P 500 Index (SPXSM) "covered" call option.

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View from the Observation Deck 

Companies often return capital to their shareholders through dividend distributions. The practice is so common that as of 4/6/23, 397 of the constituents in the S&P 500 Index (“the Index”) distributed a cash dividend to shareholders. There are currently 503 stocks in the index. In addition to acting as a conduit for return of capital, dividend distributions account for a significant portion of the Index’s total return. According to data from Bloomberg, dividends contributed to over 38% of the total return of the Index over the 95-year period between December 30, 1927, and December 30, 2022.

• Data from Bloomberg indicates that the dividend payments from the constituents in the Index totaled $67.57 per share (record high) in 2022, up from $60.54 (previous record high) in 2021. As of 4/26/23, the estimates for 2023 and 2024 were $70.09 and $74.81, respectively. 
• Of the 11 major sectors that comprise the S&P 500 Index, eight of them had yields above the 1.67% generated by the Index over the period captured by the table. Financials, Information Technology, and Health Care contributed the most to the Index's dividend payout at 15.23%, 14.78% and 14.69%, respectively. 
• A dividend payout ratio of 60% or less is typically a good sign that a dividend distribution is sustainable, according to The Motley Fool. A dividend payout ratio reflects the amount of money paid out as a dividend relative to a dollar's worth of earnings. In Q4'23, the payout ratio on the S&P 500 Index was 35.25%.
• Many investors view changes in dividend distributions as an indication of strength and or weakness in the underlying company. For that reason, companies will often avoid decreasing or suspending their dividend payout. Year-to-date through 4/6/23 a total of six companies in the Index decreased their dividend distribution, and two companies suspended their payouts. For comparative purposes, not a single company in the Index suspended their dividend in 2022, and only five dividend reductions were recorded over the period.
• Click here to access our last dividend profile post on 11/29/22.

Takeaway: Dividend distributions continue to be one of the most efficient methods by which companies can return capital to their shareholders. In 2022, the companies that comprise the S&P 500 Index distributed a record $67.57 per share to their equity owners. Additionally, dividend distributions have contributed meaningfully to the performance of the S&P 500 Index, over time. In the 95-year period between December 30, 1927, and December 30, 2022, more than 38% of the total return of the Index came from dividend distributions, according to data from Bloomberg. That said, investors may want to watch dividend sustainability over time. In our view, the recent uptick in dividend reductions and suspensions, while not severe, is a signal that certain areas of the Index may be coming under pressure as revenues contract and margins decline.
 
This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is a capitalization-weighted index comprised of 500 companies used to measure large-cap U.S. stock market performance, while the 11 major S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector.

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View from the Observation Deck

We update today’s table on a regular basis to provide insight into the variability of sector performance by market capitalization. As of the close on 4/21/23, the S&P 500 Index stood 13.82% below its all-time closing high, according to data from Bloomberg. The S&P MidCap 400 and S&P SmallCap 600 Indices stood 14.15% and 20.87% below their respective all-time highs.

• Large-cap stocks, as represented by the S&P 500 Index “(LargeCap Index”), posted year-to-date (YTD) total returns of 8.20%, significantly outperforming the S&P MidCap 600 (“MidCap Index”) and S&P SmallCap 400 (“SmallCap Index”) indices, with total returns of 3.30% and 0.71%, respectively, over the period (see table).
• Sector performance can vary widely by market cap and have a significant impact on overall index performance. Three of the more extreme cases in 2022 were Energy, Communication Services, and Consumer Discretionary. In 2023, it is Communication Services, Financials, Technology, and Energy that appear to be contributing the most to the performance differential between the selected market caps.

Communication services stocks, which have been among the top performing sectors YTD, represented 8.04% of the weight of the LargeCap Index at the close of 4/24/23. By comparison, communication services stocks made up just 2.12% and 2.27% of the MidCap and SmallCap indices, respectively. Additionally, recent turmoil in the global banking system appears to have had an outsized impact on mid and small-sized financial companies when compared to their larger counterparts. As the table reveals, financial companies in the MidCap and SmallCap indices have suffered YTD total returns of -7.12% and -13.60%, respectively. For comparative purposes, even though financials are the worst performing sector in the LargeCap Index, they only experienced losses of -2.44% over the period.

• As of the close on 4/24/23, the price-to-earnings (P/E) ratios of the three indices in today’s table were as follows: S&P 500 Index P/E: 18.59; S&P Midcap 400 Index P/E: 12.47; S&P SmallCap 600 Index P/E: 13.02.

P/E ratios have come down for all three of these indices since our last post on this topic (Click here to view that post). That said, when viewed strictly through the lens of valuations, U.S. mid and small-sized companies continue to offer more attractive P/E ratios when compared to their larger counterparts. We would like to note, however, that if the U.S. economy continues to weaken in the coming months, it is our opinion that investors may seek out the stability that larger, more established companies tend to offer. In our view, this would likely add ballast to the prices of those larger companies.

Takeaway: From a valuation perspective, mid-cap and small-cap stocks remain attractive when compared to their large-cap peers. That said, larger companies can be viewed by some investors as being more stable during periods of economic turmoil. If economic data continues to sour in the coming months, it is possible that large-cap stocks could continue to enjoy the performance advantage they’ve built over their peers. On the other hand, investors with longer time horizons may view the current valuations in small and mid-cap stocks as comparative bargains. Over the 10-year period ended 4/24/23, the average monthly P/E ratios for the three indices was as follows: S&P 500 Index: 20.30; S&P MidCap 400 Index: 21.66, and S&P SmallCap 600 Index: 25.93, according to data from Bloomberg. As of market close on 4/24/23 the P/E ratios for those indices stood at 18.59, 12.47, and 13.02, respectively. 

 
This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is a capitalization-weighted index that tracks U.S. stocks with a small market capitalization. The 11 major sector indices are capitalization-weighted and comprised of S&P 500, S&P MidCap 400 and S&P SmallCap 600 constituents representing a specific sector.

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