Source: Jin10 Data
The performance of the S&P 500 index as a whole and under equal weighting can be described as two different situations. Under equal weighting, the S&P's growth rate this year is actually less than 5%.
Despite facing the highest interest rates in decades, why is the performance of the US stock market still outstanding?
The latest market analysis shows that it's leading.$S&P 500 Index (.SPX.US)$Large-cap tech stocks with huge cash reserves are less affected by changes in interest rates. Also, since the S&P 500 index is calculated based on market capitalization, small and medium cap stocks that have been struggling due to high interest rates have not dragged down the overall performance of the index.
The market capitalization-weighted S&P 500 index doesn't show the pain suffered by small-cap stocks.
In the past year, tech giant "The Seven Sisters" led the US stock market surge amid the AI boom. However, due to a significant difference in interest rate sensitivity between large-cap and small-to-mid-cap stocks, the overall performance of the S&P 500 index and its equally weighted version are as different as night and day—the influence of US monetary policy on the stock market has just been distorted by super-cap-weighted stocks.$NVIDIA (NVDA.US)$, $Microsoft (MSFT.US)$, $Apple (AAPL.US)$ and $Alphabet-A (GOOGL.US)$/$Alphabet-C (GOOG.US)$However, Large-cap and small-to-mid-cap stocks have a significant difference in interest rate sensitivity; hence the overall performance of the S&P 500 index is quite different from its equal weight calculation—US stocks have not escaped the impact of US monetary policy, but this impact has been distorted by large-cap weighted stocks.
As of last Friday, the S&P 500 index rose more than 10% year-to-date, but the equal-weighted version grew by less than 5%.
From the perspective of interest rate sensitivity, the correlation between the S&P 500 index and the US Treasury bond yield is much lower than that of the equal-weighted version, which reflects the average performance of S&P constituent stocks. The difference between the two is at its highest level since 1999.
Media analysis indicates that as the market is divided into ten equal parts according to size, the PE ratios of each group tend to increase relatively steadily with the increase of company market capitalization. The largest tech giants have a forward P/E ratio as high as 21 times, while that of mid-cap stocks is 18 times and also higher than historical levels.
The reason is simple: Large-cap tech stocks have huge cash reserves and can lock in low interest rates for debt, even enjoying interest income from high interest rates. Conversely, small-to-mid-cap companies lack cash reserves and need to issue bonds, making them more susceptible to the impact of high interest rates. The performance of small-cap stocks this year is only 1.6%, far behind the S&P 500 index.$Russell 2000 Index (.RUT.US)$Only 139 stocks in the S&P 500 index fell last Thursday, and most of them rose, but the market fell 0.6% due to the drag of large-cap weighted stocks.
Investors' "higher and longer" interest rate concerns lead them to move away from S&P mid cap stocks. Once the interest rate cut starts, small-cap stocks with low valuations have the potential to catch up with large-cap stocks' rise.
The performance differentiation between large-cap and small-cap stocks is also reflected at a wider level. Previously, Wall Street News mentioned that the April PCE in the US showed a month-over-month decrease in personal consumption income and personal consumption expenditures, and the inflation-adjusted actual personal consumption expenditures and actual disposable personal income in April also fell by 0.1%. Consumer spending on auto, dining, and entertainment also dropped.
Recent data also shows that US consumers' real disposable income has increased only slightly over the past year, with a savings rate of 3.6%, a 16-month low, and far below the 12-month average level of 5.2%.
Similar to the stock market, the most vulnerable part of the US economy—the poorer US households and young people—have clearly felt the pressure of high interest rates, and their spending is decreasing, which is dragging down economic growth and will further transmit to mainstream retailers, financial companies, and commodity producers. However, unless the US economy enters a recession, the profitability of tech giants will not be affected.
Nowadays, the 50 cheapest stocks in the S&P 500 index have a median forward P/E ratio of only 15 times, which is roughly consistent with the P/E ratio of the market during the lowest point after the outbreak.
Analysts expect that once the interest rate cut starts, high interest rate pressure will ease, and small-cap stocks will have the potential to catch up with the rise of large-cap weighted stocks.
Editor / jayden