Starting out 2023, we’re seeing the early stages of change in longer term trends that we believe warrants attention. Some of the trends we’re watching are the S&P 500 relative to the Nasdaq, and a breakdown of long-term bonds.
Going back to the Dot Com Crash, the S&P 500 outperformed the Nasdaq markedly, due to the S&P’s overweight to non-tech and positive earning generating companies. For instance, in June 2000, the largest company in the index by weight was General Electric. Performance of the S&P relative to the Nasdaq in 2000 peaked at the same point where we were in 2021, at the pinnacle of hype for ‘disruptive innovation’.
Once the Dot Com Crash occurred in 2003, the Nasdaq has outperformed the S&P, and did so for nearly twenty years.
Source: Stockcharts.com
In 2021, the S&P 500 bottomed out relative to the Nasdaq at nearly the same level as it reached during the Tech Bubble. It has since broken out to the upside against the most reasonably shallow, and conservatively drawn downward trendline. On a short-term basis, it’s reasonable to expect some choppiness, but we are seeing the formation of a new upward sloping trend line.
To get a sense of the changing market dynamics, look at the Vanguard Total Bond Market Index Fund back to 1990. If we look again at the shallowest long-term trendline, we see the index just started to break trend to the downside.
Source: Stockcharts.com
The bottoming of the S&P/Nasdaq relative chart and breakdown of the bond indices suggests the rout in growth stocks relative to non-growth stocks is not over. It also suggests the bond market will continue to be under pressure, at least in the short-term. This makes sense, as growth stocks receive more of their earnings in the future relative to non-growth stocks, and bonds generally fall when interest rates rise. By pushing interest rates higher, the discount rate used on growth stocks goes up and subsequently values future earnings less. If future earnings are worth less today, then it’s reasonable that growth-oriented businesses underperform.
Traditional fixed income and growth-oriented businesses have benefited from a general decline in interest rates over the last 30 years, fueling tremendous positive price changes in both stocks and bonds. As we head into 2023, we see these trends coming under pressure and will monitor them for portfolio implications.