In years to come, 2023-24 will be recognised as a special period for owners of shares, something to toast with an equally special Grand Cru.
This past year the S&P 500 delivered the best annual returns this century, comparable to the recovery from the panic drawdowns of 2008 (global financial crisis) or 2020 (Covid-19).
The index, up 30% in the 12 months to September, was generously valued a year ago at 21 times earnings. It is now even more expensive, valued at 25 times reported earnings.
The average S&P price-to-earnings ratio since 2000 has been 19.7 times. Unusually, it has not taken a drawdown to lead to a strong recovery. This time has been different. Strength on strength.
The upward direction of the S&P index recently has been dominated by a few stocks — the so-called Magnificent Seven — making the index unusually concentrated and less diverse and therefore more risky than usual.
The top three by market value — Microsoft, Apple and Nvidia — constituted 20% of the S&P 500 this year, while the top seven stocks accounted for 32%. Yet while the S&P 500 was up 22% in the year to September, the equal-weighted S&P 500, the average listed company, is up a mere 14.9%. During the first half of the year the S&P 500 rose 15.2%, while the equal-weighted S&P 500 increased only 5% over the same period.
This greater than 10 percentage point performance gap between the weighted and unweighted indices was the widest in nearly 30 years. Only about a quarter of S&P 500 stocks kept pace with the market’s overall return during the first half of the year, with more than a quarter experiencing negative returns.
If you did not own the very largest stocks and own them in volume, you probably underperformed the indices. Risk (less diversification) and return were, as usual, well correlated.
Investment case
The Magnificent Seven, and so the market, are valued for the prospective growth in demand for artificial intelligence, for which they supply the backbone. But their investment case, so strongly appreciated, will only be fully revealed over time.
This makes their valuations less dependent on near-term earnings, and so on the essentially short-term business cycle. They are valued far more idiosyncratically than the average value company on their own recognisances.
They have also grown earnings and cash flows at well above the average rate to date. These super-growers with impressive track records are allocating truly enormous volumes of internally generated cash flows to supplying the essential facilities the average firm will be drawing on, and hopefully paying up for.
They also have the financial strength to pay dividends and buy back shares. In contrast, the average S&P 500 company is valued more heavily on the short-term outlook for the US economy, about which there has been and perhaps will always be considerable uncertainty.
The JSE has also enjoyed a great year, up by as much as the S&P since October 2023 — 40% in dollar terms and still impressively 28% higher in the mighty rand. The JSE all share index has added as much to SA portfolios as would have been added were they holding the S&P index — a wealth-adding outcome for old-fashioned reasons.
The prospect of faster growth has fired up the share market and the value of RSA bonds and the exchange rate. Less inflation, lower interest rates and faster growth in GDP and government revenues has been heady stuff.
It will perhaps be enough to add to the prices bid at the Wine Guild Auction and deserve an early toast to the government of national unity.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
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