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Month: August 2018

What the ‘other’ stock market is saying

What the ‘other’ stock market is saying

Ask a young Wall Street pro about the New York Stock Exchange Index and they may tell you they’re familiar with it, but that it’s no longer relevant. After all, the Standard & Poor’s 500 Index is what “everyone” follows.

“Everyone” wants to beat it and any money manager that can’t beat the S&P 500 index SPX, +0.62% in a particular year is a big loser … right?

And even if the S&P 500 isn’t all you look at, you need to look no further than the Nasdaq Composite Index COMP, +0.86% to see how the “market” is doing, right? After all, most of the cool kids — stocks — hang out on the Nasdaq. That’s where the hot tech IPOs blast off, and biotech companies with a shot at saving the world with one drug list their stocks. But the NYSE Composite Index NYA, +0.51% ? The one that simply includes all the stocks listed on the old-fogie New York Stock Exchange? Following that thing went out with knickers, black and white TV and typewriters, didn’t it?

I will admit I didn’t think much about the NYSE index myself until recently. Then, as I examined the performance of a group of stock indexes to try to summarize the current market environment, I noticed something: This year (through Nov. 19), the NYSE Index (without dividends) trails the S&P 500 Index (without dividends) by a very wide margin compared with most years. Then, with some quick number crunching by Sungarden research analyst Mark Jakupcik, I realized that 2013 exhibited the same pattern. So did 2011 (though 2012 had them about even). A table at the end of this report summarizes the data, year by year.

We looked back about three decades and found only one other time that the NYSE underperformed the S&P 500 by such a large amount. It was in 1998 and 1999, the two years preceding the dot-com bubble in stocks. That was also the last time I can recall feeling like buyers of quality companies were viewed as out of touch, and where S&P 500 performance envy was as rampant as it is today. This is a disturbing pattern to us, and while it may not portend bad times for stock investors in the very near future, it bears watching (no pun intended).

OK, so now you’re thinking that this may just be a coincidence. After all, there were probably plenty of things that happened in the late 1990s that have not occurred again until recently. It doesn’t mean history will repeat itself. But this is what we are watching: The NYSE requires much more stringent listing requirements than the Nasdaq. A lot more capital is required to maintain a stock’s listing on the NYSE, and so in general, NYSE contains more stable companies than the Nasdaq. So if the S&P 500 is leaving the NYSE in its dust, it may mean that investors are shunning high quality for lower quality. When high-fliers are in vogue at the expense of blue chips, it should catch our attention.

The S&P 500 not only contains all of the kings of the Nasdaq (you know, the cool stocks), but it also weighs its constituents by the amount of outstanding stock (aka “market capitalization”). That means that as investors’ favorite stocks are bid up in price, the weighting of those stocks gets bigger within the index. The longer that goes on, the narrower the market index gets. Back in 1999, the entire gain of the S&P 500 was accounted for by a very, very small number of holdings. But people think the “market” is up because they don’t read past the headlines. By contrast, the NYSE is equal-weighted, so the self-fulfilling prophesy that surrounds the S&P 500 Index isn’t present.

We think a preference for “popular” stocks is in progress again. It is a condition that can build silently for a while, but often ends badly, as it did after 1999. Compounding the issue today is the fact that so much money is being attracted to index funds that mimic the S&P 500. This wasn’t the case during the decades in which the NYSE and S&P 500 returns were so closely aligned. I believe this is one of the biggest factors in this recent pattern. It is like a self-fulfilling prophesy on steroids — until something reverses the tide (a disturbing piece of news, or maybe just some big money players deciding its time). Then, a snowball effect can be in play. This is what happened in the late 1990s and the early part of the next decade.

Summary: the “market” that is the S&P 500 is having a good year to date and has had a great run for this entire decade, following the bottom in early 2009. The “market” that is the NYSE is telling a different story, as are many of the other major stock indexes here and abroad. After two years of this type of behavior, it is a good idea for S&P 500 followers and anyone concerned about the impact on their wealth of the next three to five years to keep the NYSE Index in their thoughts as well.