After Booming 2019 for Stock Indices, U.S. Equity Markets Going Back to Fundamentals

Monetary policy helped create a roaring year for stock indices in U.S. equity markets in 2019. Led by the U.S. Federal Reserve (Fed), dovish global central bank guidance and eventual rate easing sent stocks to their largest gains since 2013. As a result, the Fed is likely to hold in 2020, with communications indicating the “insurance” cuts are over.

Modest global growth likely will continue. It should be supported by the resilience of the U.S. consumer, despite continued weakness in global manufacturing. Earnings should take center stage as markets look beyond the Fed for the next growth catalyst. Multiple expansion accounted for 92% of the market’s 2019 appreciation, as valuations raced ahead of profits.

But there is a risk of complacency. The Global Economic Policy Uncertainty Index has reached an all-time high, but implied equity volatility has not followed suit. We expect volatility to rise.

U.S. equity markets are at their top-heaviest since 1999. Apple gained more in equity value in 2019 than any other company in history, its stock surging 86%. This sent Apple’s market cap to $1.3 trillion, a gain of $556 billion. That valuation is bigger than all but the top four S&P 500 companies – and roughly equal to the entire Spanish or Italian stock markets.

The top five stocks (Apple, Microsoft, Amazon, Facebook and Alphabet) make up about 17% of the S&P 500 Index. This exceeds tech bubble concentration (13.66% among General Electric, Exxon, Pfizer, Cisco and Citigroup in December 1999). An earning miss or adverse news from one or more of these companies could have outsize effects on the total market.

Passive ascendancy may be contributing to this mega-company dominance. Over the past 10 years, the U.S. stocks that outperformed the broad market were mostly mega caps. Only 32% of stocks in the S&P 500 index managed to beat their index; almost half did in the previous decade.

Up from just 20% 10 years ago, passive investing represents about half of U.S. fund assets. The money pumped into index funds benefits larger companies disproportionately, because their benchmarks are mostly weighted to market cap. A decade ago, about 15 cents of every dollar put into SPDR or Vanguard 500 index went into technology stocks. Today’s share is about 25 cents.