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In a couple of weeks, final second quarter EPS for the S&P 500 will confirm the fastest recovery ever from a recession-related earnings decline. That’s old news, and before it has even hit the tape. But we’ve had a sneak peak from the monthly, 12-month trailing EPS numbers published by MSCI for its USA Large Cap Index. Those figures showed that EPS exceeded their pre-COVID peak in May, and the latest reading (through August) is already 22% above the prior high! Simple trendline analysis suggests that EPS for U.S. Large Caps are likely higher today than they would have been in the absence of the COVID pandemic and hyper-stimulative response. 

Quant researchers widely agree that Value offers a return premium over time (although not recently) and that High Quality also offers excess returns. The Quality angle seems contrary to intuition, in that investors generally prefer Quality companies and are willing to pay up for them, yet Quality regularly outperforms. Value and Quality are both well-respected investment factors, and we were curious to explore the interaction of these two smart beta stalwarts. Is Value enhanced by adding a layer of Quality, thereby avoiding value traps, or are Value investors better off buying junky, unattractive companies that have the most room to rebound from depressed prices?

Read this week's Major Trend Index

Read this week's Major Trend update

Stimulus and soaring stock prices have contributed to the fastest consumer-confidence rebound of any economic recovery on record. Yet the manner in which this bounce has unfolded is anything but “early cycle.”
 

Fading momentum in GDP growth, sizable dislocation of corporate EPS in the midst of an expansion, and U.S.-dollar weakness have all made EM equity investments inferior to U.S. stocks over the last decade. 

There are some positive cyclical influences for Small Caps, like higher inflation and deeply negative real interest rates. But in our minds, the valuation spread versus Large Caps is more important. 

Those in their peak earning years (40s and 50s) who’ve also enjoyed the stock market’s windfall gains are very likely to have seen their annual expenses climb much higher than the Consumer Price Index over the last several years.

In the middle of the last decade, we marveled at the Tech sector’s ability to flog the rest of the market quarter after quarter, with no meaningful breakout in valuations. Specifically, the median Price/Cash Flow ratio for S&P 500 Technology managed to “hug” the 15x level for about four years beginning in late 2013. Tech’s post-COVID boom is nothing of the sort.  

The impact of U.S. stock-market “hegemony” extends far beyond currency markets. We believe the mania has progressed to the point where the stock market itself will shape the intermediate-term and even long-term fortunes of the U.S. economy more than it ever has before.

It’s been a heck of a stock market year, and there are still four months left. What else could go right? Monetary conditions, for one thing—at least as proxied by our Dow Bond Oscillator (DBO).

The market’s August push was enough to lift four of the seven lagging bellwethers to new cycle highs. Among the three remaining laggards, only the Dow Jones Transports is still significantly below its high.

It seems investors care mostly that the authorities have fiercely defended the S&P 500’s status as the World’s Reserve Index^TM. A decade of QE should have taught us that when the Fed conducts a decade’s worth of QE in little more than a year, U.S. Large Cap stocks benefit the most. 

Financials have dramatically improved their Growth profile; a move that makes the traditionally value-oriented sector one of the most well-rounded segments of the equity market.

Financials, Information Technology, and Consumer Discretionary remain at the top of our sector scores. Health Care advanced up to 4th from 6th. Communication Services and Materials both dropped one spot moving to 5th and 6th, respectively. Real Estate, Energy, and Utilities are the three-worst rated, which has been the case for over a year.

If there are shortages, bottlenecks, and commodity inflation everywhere, why is the rating for the Materials sector so uninspiring? Although valuations are compelling for Materials groups, the overall decline in the rankings can be traced to EPS revisions and macro influences, like the U.S. dollar and low rates.

Read this week's Major Trend.

The S&P 500’s stunning recovery off the COVID-panic market bottom hit another milestone in mid-August—a 100% price gain from its March 23, 2020 closing low. The quickest “double” from a bear-market low in the index’s history was still six- to seven-months slower than the “doubles” experienced by the Russell 2000, S&P 400, and the Nasdaq Composite.

Large Cap Growth continued its streak of outperformance over Value (and everything else). This Growth/Value dynamic has been much more muted in Mid and Small Caps.​

Using non-normalized trailing operating earnings, Small Caps are selling at a 21% valuation discount to Large Caps. The relative underperformance of Small Cap stocks continues to push our Ratio of Ratios lower: Over the last six months, the S&P 500 has outperformed the Russell 2000 by almost 16%.