Centerfin Collective Weekly

Weekly Update May 5, 2023

13.3% of the S&P 500 is 2 companies, 10th Fed hike - and more banks teeter, the Fed's labor market problem

13.3% of the S&P 500 is just 2 companies

This week, the weighting of Apple (AAPL) and Microsoft (MSFT) combined reached 13.3% of the index representing 500 companies. This is the most 2 stocks in the index have represented since its inception. Given that the S&P 500 is a market-weighted index, the larger companies' market caps get, the larger their overall representation. Given both stocks are up 29-34% for the year, they also are responsible for a significant chunk of the index return year-to-date.

  • The S&P 500 is one of the most widely used indices in the US and the world
  • Given the S&P 500 is a market-weighted index, as companies’ market caps grow relative to the rest, their representation in the index grows
  • Since AAPL and MSFT have experienced tremendous growth over the prior decade, they now represent over 13% of the index
  • Passive investing usually involves buying an index, such as the S&P 500
  • Investors should understand that only 2 companies dominate the broader index, which is not the intent of passive index investing
  • Meanwhile, Apple reported its second consecutive quarter of DECLINING sales, and its stock rallied, boasting a P/E (price/earnings) ratio close to 30x
  • It's hard to square such a high valuation for a company that is no longer growing, except that it is used as a safe haven in uncertain times

10th Fed hike - and more banks teeter

The Federal Reserve raised interest rates for the 10th time in a row to 5-5.25%. You can now invest risk-free and get over a 5% yield. During the press conference, Jay Powell, the Chairman, hinted that they are getting close to the end and that further hikes may or may not happen. He, however, brushed off any notion of cutting rates any time soon. The bond market disagrees, with multiple rate CUTS priced in through 2024.

  • We have written before that the Fed may be doing more harm than good in continuing to hike
  • Inflation is heading in the right direction, and the incremental rate hikes seem unnecessary
  • The unintended consequences are potentially worse; case in point, 3 of the largest bank failures this year since the financial crisis
  • The Fed proclaimed that with the purchase of First Republic by JP Morgan, the bank crisis seemed to be contained
  • The following day, two additional banks (Pacwest and Western Alliance) saw their stocks come under significant pressure
  • The yield curve is now significantly inverted, i.e., short-term rates are higher than long-term rates
  • Banks borrow short and lend long; this significantly affects their profitability
  • The longer the curve stays inverted, the worse it will get

The Fed’s labor market problem

Today the non-farm payroll numbers came in stronger than expected, with the economy adding over 250,000 jobs and the unemployment rate dropping to 3.4%. Wages were also up 0.5% on the month, accelerating over the prior month. All the numbers were better than expected, complicating the job for the Federal Reserve.

  • The market for jobs remains extremely tight
  • Wage inflation continues to be stubbornly high
  • Having just hiked rates for the 10th consecutive time to the highest level in 16 years, the Fed is now in an even tougher position
  • The Federal Reserve’s goal is to weaken the labor market to cool inflation
  • To date, while inflation is coming down, the labor market continues to be very strong
  • The longer the labor market remains strong, the less likely it is for the Fed to reverse its rate-hiking cycle
  • The strength in labor is also hard to square with the calls for a coming recession

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