The stock market’s breadth stinks. Breadth is the measure of the rally’s broad based support. In my last article, I mentioned how Apple is responsible for all the gains in the Dow. The chart below shows that since March 1st, the fantastic five tech stocks which are Facebook, Apple, Amazon, Netflix, and Alphabet gained $260 billion in market cap while the rest of the S&P 500 lost $260 billion in market cap. At the end of bull cycles, there’s a period where the index is dragged higher by a small group of companies which are still doing well. The ‘risk on’ nature of the stock market wants to continue, despite weakness in a wide swath of stocks, so everyone piles into the winners.
In 2007 and 2008, the winners were the fertilizer and oil and gas firms. Stocks like Chesapeake and Agrium more than doubled in this period. Commodity stocks are cyclical, so the trend didn’t hold. This time stocks like Tesla and Netflix are rallying without positive free cash flow. Apple and Microsoft are being boosted by large buybacks. This brings me to Microsoft which should have been included in this chart to make it starker. Microsoft stock is up 6.28% since March 1st which is equivalent to a $32 billion increase in market cap. This means since March 1st, those 6 firms have gained $292 billion in market cap and the other 494 firms lost $292 billion in market cap.
The chart below shows the buybacks Apple has pursued to get its stock moving higher. Buybacks, of course, don’t improve market cap because the market cap is the share price times the number of shares outstanding. The number of shares declining decreases the market cap. The market cap has been able to move higher because the share price has increased more than the share count has been reduced. As you can see, Apple has reduced the float by 21% in the past 4 years while the share price has moved 147% higher even while iPhone shipment growth has stagnated. The key to this is excessive risk taking by investors along with Apple’s shift to improving its services business which has high margins.
While Apple’s effect on the market is growing by the day as its market cap gets closer to $1 trillion, its effect on the S&P 500 is not unusual compared to previous market cap leaders. As you can see, AT&T, IBM, and Exxon Mobil have had higher influences on the S&P 500 in relation to the 2nd biggest firm. Apple being the market leader is not such great news for the firm because leaders are usually surpassed after a few years after market dynamics change. Microsoft’s dominance was reflective of the tech bubble, GE’s dominance in the early 2000s was helped by GE Financial which ended up being hurt by the housing bubble, and Exxon was helped by rising oil prices. The rise of the mobile internet has helped Apple, but the commoditization of smartphones may pressure margins in the future.
While the wealth inequality gap remains large, the correlation among various income levels’ expected spending growth since 2013 has been high. The consumer spending growth is declining across the board, regardless of income. As you can see in the chart below, those making over $100,000 and those making under $50,000 per year have pulled back on spending. Real spending growth in Q1 was barely above flatline and the latest consumer expectation survey from Gallup showed weakness, so it’s not surprising to see median expected spending growth fall from 5% in 2013 to 2.5% now.
Even though larger firms have had better stock performance and margin performance, the chart below says that large & middle-market commercial and industrial loan demand is down. This chart looks like the Citi Economic Surprise Index in that it fell in late-2015/early 2016, rebounded, and now is falling again. The longer the cycle goes, the more relevant negative demand for C&I loans becomes. Corporate debt as a percentage of GDP is at a record high which means any signal that demand is waning could be a pivot point. Firms need to keep piling up the debt to keep the game going. If they stop, the bubble stops inflating and bursts. As was mentioned previously, there’s been a slowdown in buybacks, but there has been an escalation of bond offerings. That toxic combination has been the result of excess leverage and declining earnings. We will see if the recent earnings rebound improves buybacks and the C&I loan demand from large and mid-market firms.
It’s not surprising that the demand for C&I loans from smaller firms is weakening, given how weak small firms are doing compared to large ones. Keep in mind, I’m referring to the weak S&P 600 margins, not the hiring rate of small businesses which was shown to be strong in the April ADP report.
The pivotal question is when small business optimism will wane. While the surveys aren’t reflective of changes in business activity, they are reflective of changes in hiring. As you can see in the chart below, the percentage of small businesses with one or more unfilled positions is the highest in over ten years. Small businesses are responsible for 2/3rd of hiring, so this chart is important. One would expect hourly earnings to be increasing at a faster clip given the jobs that need to be filled, but it hasn’t occurred yet.
Conclusion
Apple’s buyback has a large effect on the total market’s performance as investors’ capital has flowed to the large tech firms. The S&P 500 would be down without Apple, Microsoft, Alphabet, Netflix, Facebook, and Amazon. Even though large firms are seeing margins improve, they’re lowering their demand for loans just like small firms. The key will be determining when small businesses slow their hiring rate. The consumer is already lowering its spending. When the labor market starts to weaken, the consumer’s spending growth will only worsen. It will be interesting to see if fixed investments can maintain their growth in Q2 with C&I loan demand softening.
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