2023-07-25 10:50:30 ET
Summary
- The S&P 500 is expensive until you pull out the Magnificent Seven.
- Look beyond the top 10 names in the index and you can find lots of value.
- The small-cap indexes are at significant discounts to their historical valuations in relationship to the S&P 500.
The Dow Jones Industrial (DJI) is on a roll, with eleven consecutive days of gains. If we were not due for a pause before, we surely are now, but a pause or pullback in the major market averages does not mean investors should become more risk averse. I think it does suggest we need to be more tactical in our approach to investing in risk assets at this stage of the bull market. The incoming economic data continues to support the outlook for a soft landing, which should also bring an end to the Fed’s rate-hike campaign this week, and fuel additional stock market gains during the second half of this year.
The S&P Global PMI Flash Composite is a mid-month survey of purchasing managers in the manufacturing and service sectors. With readings above 50 indicating growth, the index declined 1.2 points in July to 52, which is consistent with an annualized rate of economic growth of 1.5%. That’s just right if we want to continue seeing disinflation. More importantly, and as I indicated we would see in my report yesterday, the service sector is softening, while the manufacturing sector is making a gradual comeback. The manufacturing index rose from 46.0 in June to 49.0 this month, which is on the cusp of a return to growth. This is a goldilocks number for the soft-landing camp.
Regardless, the bears continue to obsess about overvaluation for the S&P 500 Index (SP500), but they are myopically focused on the Magnificent Seven. These mega-cap technology behemoths account for a record 28% of index value and most of the index gains this year, but as I’ve mentioned in recent weeks, the rally is broadening. Investors need to look beyond names like Apple (AAPL), Google (GOOG), Meta Platforms (META), Tesla (TSLA), Amazon (AMZN), Microsoft (MSFT), and Nvidia (NVDA) for value. In fact, the price-to-earnings multiple for the ten largest companies in the index is approaching 30! The remaining 490 stocks have an average P/E of 17.8 times, with a significant number well below that multiple. There is plenty of value left in this market.
Even greater value can be found in smaller companies. According to Sam Stovall at CFRA Research, the S&P 600 small-cap index is trading at more than a 30% discount to its historical 12-month forward price-earnings multiple. This is probably because of recession fears, as smaller companies tend to be more domestically focused, but therein lies the opportunity for the soft-landing camp.
The Russell 2000 small-cap index ( RTY , IWM ) has made a triple top at approximately $198, which I expect it to break above during this earnings season. That would be the most important confirmation that the bull market is broadening with more upside ahead.
This earnings season should be supportive of higher stock prices, as we are at an inflection point when year-over-year growth should start to resume in the third quarter. The outlook strengthens dramatically when we exclude the energy sector, which is realizing the largest decline in year-over-year earnings, due to the plunge in commodity prices over the past year. Still, this sector may present one of the best opportunities moving forward as the technology sector gives way to more cyclical and value-oriented sectors.
For further details see:
Look To Invest Beyond The Magnificent Seven