Was That It?

William Ehart

HOPE SPRINGS ETERNAL for mega-cap tech, meme stocks and cryptocurrencies. And the bond market is starting to party again, too. True, the financial markets have pulled back in the two trading days since Friday morning’s strong jobs report. Still, year-to-date performance has been startling.

Investor’s Business Daily reported recently that just 10 stocks, including Apple, Amazon, Tesla, Alphabet (parent of Google), Nvidia, Microsoft and Meta (parent of Facebook), have accounted for half of the S&P 500’s 7% year-to-date rally. Bitcoin is up more than 38% since year-end 2022, and movie-theater meme stock AMC has jumped 67%. Meanwhile, though the Federal Reserve continues to raise short-term interest rates, iShares Core U.S. Aggregate Bond ETF (symbol: AGG) and iShares iBoxx High Yield Corporate Bond ETF (HYG) are up more than 7% since late October.

So, is the bear market behind us? Was that it? Is big tech back? Color me skeptical, especially on that last question.

The four biggest technology stocks in the S&P 500 as of December still represented a greater percentage of the index than the four largest did at the peak of the dot-com bubble, notes Goldman Sachs. Valuations in the rest of the stock market may look good, but can the same be said for mega-cap tech?

The market seems to be sending mixed signals. Intermediate and longer-term Treasurys are trading as though the Fed will soon start cutting rates, perhaps as the result of a recession. Yet stocks and high-yield bonds are acting as though corporate profits and the ability to repay debt will weather any economic slowdown.

The spread—or extra yield—of high-yield bonds over Treasurys is just under four percentage points, below the 25-year average of 5.4. During past recessions, the high-yield spread has reached eight percentage points and sometimes much higher, including 11 points in 2002 and 20 points in 2008. If the yield spread were to widen to eight points, that would mean steep losses for high-yield “junk” bonds.

The rally in bonds and growth stocks caught me a little flat-footed. My lean toward value stocks and short-term Treasurys—which benefited me so much last year—is causing me to miss some of this year’s headline-grabbing action. I had expected the cycle of value outperformance to last at least a few years, as happened after 2000, when the dot-com bubble burst.

The good thing is, I didn’t bet the farm on that. I’m fully invested based on my target asset allocation. Index funds and balanced funds make up most of my portfolio. That means I’m capturing much of 2023’s unexpected upside—but not all of it.

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