Markets have started 2023 off much like 2022 with a spastic demeaner that is tough to trust. After a depressing December with Santa Clause seemingly stuck in a chimney, January ushered in a strong oversold bounce led by some of the most beaten-up names. Markets rejoiced in a softer than anticipated CPI and what seemed to be a more accommodating Fed. Hopes were quickly dashed as we rolled into February when the CPI’s stepsister, the Producer Price Index (PPI) notched a hotter than anticipated gain. Stocks retreated with the idea that inflation was far from under control, and the Fed may have to continue in its interest rate pursuit. As I write and we roll into March, we can chalk up the volatility to a small gain to start the year, which I guess is, at minimum, a step in the right direction.

There seems to be a hotly contested debate surrounding the economic future and whether we’ll see an actual recession. The insinuation, of course, is not so much the definition but rather that the economy will take a significant turn for the worse with stocks heading lower from here. Not a week goes by that I’m not asked my opinion. I take quite a different view, which I believe to be worth discussing in detail here.

When folks refer to the ‘market’ they’re often referring to the S&P 500 or 500 of the largest domestic companies lumped into a basket. You may often hear someone say something like, “The market was down 20% last year” or “I think the market will continue lower.” When you hear this, you can safely assume someone is talking about the S&P 500. On a daily basis however, when someone says, “The market was up 800 points today” or “The market was down 1,000.” that person is now talking about the Dow Jones Industrial Average, which is comprised of 30 US based stocks. You may often hear people refer to price points in the Dow such as 30,000 or 20,000. It’s not worth dissecting why we use the terminology that we do, but rather I want to focus on the S&P 500 and share with you how this average is constructed.

The S&P 500 is made up of 11 sectors with a variety of stocks designated to each sector. Common sense would assume that if you buy an S&P 500 index fund you’re getting 1/500th of each stock when nothing could be further from the truth. In reality the stocks held within the S&P 500 are weighted based on their total market cap. Market cap is the total publicly traded value of the company, or shares outstanding, multiplied by the stock price. Over the last few years, big cap technology stocks have grown to such size that at one point, 5 stocks made up more than 1/2 of the entire S&P 500. This meant that when you invested $1.00 into the S&P 500, .50 or half was split up among 5 companies with the remaining .50 being spread out among the remaining 495. Ironically, when folks thought they were diversifying by adding the S&P 500, in reality they were only diversifying half of their money with the other half going into just a handful of stocks. You may have even heard the term FAANG, to represent the original top 5 stocks through Facebook (Now META), Apple, Amazon, Netflix and Google (Now Alphabet).

Since the market bottom in 2009, there were two things that propelled the S&P 500 to the levels we’ve seen. The first being the dominance and growth of these large tech companies such that their own outperformance helped the general market. However, something else, which is difficult to measure, but significant nonetheless, was the seismic shift among investors away from any active management into passive S&P 500 funds. Thus, allocating their assets into these names to a greater and greater extent. Think of the math for a bit. If you have inflows into the S&P 500 where half of the money goes into 5 stocks, their size will only continue to grow compared to other companies and therefore the compounding of the size will just grow and grow. That is of course until the music stops and those companies no longer grow at the rate they had in the past.

At some point, the economies of scale of an organization become so large that it becomes difficult to grow at the rate they had in the past. For example, if you’ve doubled your business from $500MM to $1BB, in a few years, it would be foolish to think you could grow to $2BB in the same amount of time. While these numbers are big, consider that many of these names far surpassed the Billion-dollar status and ventured into the Trillion-dollar club! I don’t care how you slice it, the idea that a company can grow from $1Trillion to $2Trillion at the same speed as it grew to the first Trillion is simply out of the question. Thus, you have what we seem to be seeing right now where the largest companies slowly start to fall out of favor, while new, emerging names begin to take their place.

The process is bumpy and will take time, especially considering many of these names held these spots for so many years, but from my vantage point, that is exactly what is happening.
Rather than spend my time debating whether we’re headed into a recession, I’m spending my time dissecting new industries, new opportunities and the companies that will ultimately be emerging as new leadership going forward. While folks wallow in pessimism, I remain optimistic to see industries emerging that will change the way we work, live and experience life. You can see it too, just look around and take it all in.
There is no question that the inflation game and interest rate response will continue to act as the tide that raises and lowers all boats. However, while many become focused only on the general tide, we are busy watching the boats themselves and seeing how they navigate the changing landscape. Many out there are doing quite well and look to be just getting started.

I have been in this game for over 23 years now and can honestly say that there seems to be a crisis around every corner. I entered the markets during the Dot-Com crash and watched countless businesses cease to exist. During 9/11, markets closed for 5 days and I wasn’t quite sure my business would exist. I remember Hanging Chads, North Korean saber rattling, the Great Financial Crisis, the Flash Crash, the Greece debt crisis, Brexit, Covid and now 70’s era inflation. (I’m certain that I missed some.) One thing that remains consistent through all of this is just how resilient the US economy is, especially businesses that we interact with each and every day. As Warren Buffet likes to say, “Betting against America is a losing bet.” I tend to agree.

I’m not sure what the future will hold as we head into the spring, however what I do know is there are areas of the market we really like and others we do not. There is value in certain sectors and danger in others. The days of throwing darts are over and precision will be the name of the game!
As we enter March we celebrate our first year as a Bluespring Wealth Partner. I suspect you may have even forgotten that was a thing. I can honestly say this was one of the best decisions we’ve ever made. The organizational support we now have solidifies our business for generations to come. We’re excited to be adding more staff in the coming months and if you haven’t checked it out yet, please do take a listen to our rapidly growing podcast DIY Money.

I hope you have a wonderful spring and we look forward to serving you into 2023 and beyond!

~ Quint

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