Articles by Phil Segner, CFA Co-Portfolio Manager & Sr. Analyst

Over the entire history of this study, the momentum plays of our “Dreams” and “Nightmares” have worked both ways. This was not the case in 2023, however, as the fortunes for both groups (based on 2022 performance) U-turned in a considerable way.

The story of the year was the Magnificent 7. Even with a lackluster December, the largest seven firms produced an average return of +111% in 2023. Advances in those companies added $5 trillion in market cap and were responsible for just under two-thirds of the S&P 500’s overall gain.

Royal Blue Growth (+40%) led all of our style boxes in 2023. However, this mega-cap proxy still hasn’t recovered all of its losses from 2022.

Our preferred earnings measure, five-year normalized EPS, has grown from $145 to $171 over the last two years. The S&P 500’s Normalized P/E multiple has dipped from 32.9x to 27.9x since the end of 2021. Those two figures are good for the 94th and 81st percentiles, respectively, in our 1995-present data set.

With the books closed on Q3-23 reporting, the ratio reads 1.16—right in the middle of the depressing range captured over the past two years. This equal-weighted all-cap vignette is still flashing a warning sign about companies’ ability to grow their bottom lines.

Two years ago, the downside estimates were quite a bit more eye-popping than even today’s still alarming figures.

This looks like a market that has made up its mind about inflation and a coming soft landing. Inflation and Economic Surprises in 2023 have helped form this rosy outlook.

The S&P 500’s 9% November advance erased almost all of the previous three months’ losses. The Index now sits very close to its near-term highs set at the end of July.

As we slice and dissect November’s performance, we find comfort in the uniformity of returns for the Cap Weighted measure, Equal Weighted average, and even our market-cap quintiles—which were all up around 9%. That is a stark change from the concentration of returns seen over the last ten months. The Cap Weighted S&P 500 ended November just 1.7% shy (via either price or dividend return) of eclipsing its 23-month-old highwater mark.

Large- and Mid-Cap Growth were the biggest winners (+12-14%), although all style segments benefited from the stock market upsurge. The advance by MC Value, SC Growth, and SC Value (+9% each) flipped their YTD losses to the positive side of the ledger as of November’s close.

November’s rising tide lifted all boats and our Ratio of Ratios is unchanged from the end of October. Absolute trailing P/E values for both Large and Small Caps spiked higher with the market, but remain well below readings seen at similar S&P 500 market levels at the end of July.

Small Cap Discount = 27%

Using non-normalized trailing operating earnings, Small Caps are selling at a 27% discount to Large Caps. November’s rising tide lifted all boats and our Ratio of Ratios was unchanged from the end of October. Absolute trailing P/E values, both for Large and Small Caps, spiked higher with the market, but are well below those seen at similar S&P 500 market levels at the end of July—another testament to this vignette’s most suitable benchmarks (Equal Weighted S&P 500 and S&P 600) lagging over that time period. Looking at full-year 2024 numbers, the Small Cap/Large Cap P/E discount is narrower at 23%.

Small Cap Discount = 27%

Using non-normalized trailing operating earnings, Small Caps are selling at a 27% discount to Large Caps. November’s rising tide lifted all boats and our Ratio of Ratios was unchanged from the end of October. Absolute trailing P/E values, both for Large and Small Caps, spiked higher with the market, but are well below those seen at similar S&P 500 market levels at the end of July—another testament to this vignette’s most suitable benchmarks (Equal Weighted S&P 500 and S&P 600) lagging over that time period. Looking at full-year 2024 numbers, the Small Cap/Large Cap P/E discount is narrower at 23%.

Our ratio reads 1.15—a nice bounce from the alarm-ringing “one-month” figure of 0.94 at the end of October. Still, this result is very much in the range of the past seven quarters’ “two-month” readings, which have an abysmal tally of 1.10 on average.

As we put a fork in the S&P 500’s Q3 earnings, our snail trail is now decidedly pointing south. However, the kink you see in Chart 1 should not be viewed as an EPS collapse. An accounting sleight of hand from Berkshire Hathaway—R.I.P. Charlie Munger—shaved off just under $3/share in EPS for the index. If that were added back, the quarterly estimate of $55 would be pretty much unchanged since the start of the summer.

Phil Segner looks at the outsized contribution of the largest seven stocks in the S&P 500 on both the upside and the downside.

Read this week's Major Trend.

With October’s 2% loss, the S&P 500 has now experienced three consecutive monthly declines—a streak not achieved since the onset of the pandemic.

Another month, another yawning performance gap between the Cap- and Equal-Weighted S&P 500. Since the end of January, the more democratic of the two has underperformed the top-heavy version by nearly 14%. To find a nine-month span with greater relative underperformance for the Equal Weighted Index, you’d have to go all the way back to the very top of the Tech Bubble in March 2000.

Three of our six style boxes are now in negative territory for 2023. The Mega Cap Growth proxy—Royal Blue Growth (+16.4% YTD)—has been the only game in town.

The most appropriate proxies for this comparison, the Equal Weighted S&P 500 and the S&P 600, were down 4.2% and 5.8%, respectively, in October. Hence, the minimal 1% widening for the Small Cap discount makes sense.

The number of firms beating on both the top and bottom lines has been underwhelming thus far. Those that missed EPS estimates have seen their equity drop an average of 4-5% relative to the index. That’s quite a bit higher than the usual 2-3% decline we’d expect given the history of data.