Weight Of The World

Ever play a game of Jenga? Let's talk about the tower.

May 19, 2023

Highlights

Six companies are weighted 22.7% of the S&P 500 and have a total market cap of $9.2 trillion.
“The market is a manifestation of group psychology in motion”- Ned Davis.
Incrementally raising liquidity on Mega-Cap Tech. Re-allocating to long Gold and Bonds, while adding more shorts one step at a time.

Having Fun?

No one ever said this would be easy. Since the cycle peaked in November-December 2021, there have been multiple manic episodes. There have been periods of intense highs where people chased returns and extreme lows where others capitulated only to sell their assets at the exact wrong moment. Crazy to look back over this time and think that there has never been a middle ground. The polarity of the market has been very clear, yet the SPX has essentially traveled nowhere but sideways throughout that time. Meanwhile, the weight of the world rests on the shoulders of six companies. Many of which are doing “super cool AI things”. The chart below is the S&P 500 minus seven Mega-Cap Tech companies.

*Tradingview: SPX-AAPL-MSFT-AMZN-META-NVDA-GOOGL-NFLX

I have compared recent market movements in three ways. First, by looking at the SPX, next by observing the isolated top Mega-Cap components, and lastly study the S&P 500 without those Mega-Cap components. Unsurprisingly, the index shown above which is the S&P 500 without the aforementioned Mega-Cap Tech stocks (AKA 493 other companies) is trending lower, which is in line with the observed economic data and its trajectory.

SPX +0.94% (Thursday) and +1.79% week to date
Mega-Cap Index +3.87% (Thursday) and +6.58% week to date
SPX without Mega-Cap -0.28% (Thursday) and +0.15% week to date

Notice anything strange yet?

The data presented over the past few weeks has not changed; if anything, it has continued to decay underneath the surface. Rarely do asymmetric opportunities present themselves and it is important to take advantage. Often time, capitalizing on opportunities may cause levels of discomfort. However, one of the most important lessons that I have learned while playing “the game” is to be comfortable with being uncomfortable.

Approximately one month ago, I promised to refrain from writing about AI in my publication titled “Truckin” (link here to read). Well, tried my best to wait as long as possible, but it is time that I break my silence. Putting aside the dramatic introduction for this seemingly widely known topic of conversation, I am seriously astonished that the financial media has nothing else better to talk about. Every company management team is now talking about how they are “integrating AI”. While I am working in the office, I glance at the TV from time to time to perform a behavioral analysis by observing various headlines aired by CNBC. I do not look often, but over the last week, 9/10 glances have been to see a “cool” AI headline and topic of conversation. Does not seem like the media or market participants are thinking about anything else. Just AI.

Two books that I have read, which have been great resources about market psychology are “Beware Of The Crowd At Extremes”, by Ned Davis and “The Art of Contrary Thinking”, by Humphrey B. Neill. Ned Davis actually cites Mr. Neill’s work in his book. Additionally, Gustave Le Bon who was a French social scientist wrote a book called, “The Crowd”, which was a study of the popular mind and predominantly based upon experiences of crowds during the French Revolution. Mr. Neil derived the quote below from studying Le Bon’s work.

“An apparently irrational stock market became comprehensible. Order emerged from the chaos. The effect was finally linked to cause. I came to the initial realization, since reinforced, that the action of the stock market is nothing more nor less than a manifestation of mass crowd psychology in action”- Humphrey B. Neill.

Thinking of the present situation, I cannot help but think about how the recent price movement in the wake of AI has been a reflection of crowd psychology in action. As Ned Davis would say, “The stock market is a manifestation of group psychology in motion”. The majority of people are thinking about a few things: AI, their portfolio returns, and how to make up for last year’s poor performance. What they are not thinking about are the various deteriorating sets of economic data that have been discussed on this Substack over the previous few weeks.

As we are talking about Ned Davis, let’s discuss a brief history lesson in relation to the “weight of the world” in 1999 when the NASDAQ index gained +85.6%. Below is a breakdown of the top contributors as a percentage NASDAQ composite index total return from 12/31/1998 to 12/31/1999. The following ten companies accounted for 45.8% of the index’s gains. According to Ned Davis:

Microsoft (MSFT) 11.1%
Cisco Systems Inc (CSCO) 9.0%
Oracle Corporation (ORCL) 5.7%
Qualcomm Inc (QCOM) 4.4%
Sun Microsystems (SUNW) 4.0%
Intel Corporation (INTC) 3.6%
Yahoo! (YHOO) 2.9%
Internet Capital Group (ICGE) 1.8%
DELL Technology Company (DELL) 1.7%
Amgen, Inc. (AMGN) 1.6%

History often rhymes and no, I am not making a case to create a direct relationship between now and the Dotcom bubble. I was just re-reading some of Mr. Davis’s work and wanted to discuss the parallel because the “weight of the world” dynamic, as it applies today, has been on my mind all week.

Macro

Earlier in this note, I mentioned that the data has not inflected favorably outside of what was a minor re-acceleration in growth during Q1 2023. However, time moves forward and this is no longer Q1. Fundamentals underneath the surface are deteriorating specifically in relation to retail sales and the consumer. Do not forget that consumption contributes approximately 66% or more to US GDP. The Fed has taken extreme monetary action at the fastest pace in history. Do not be surprised if they raise rates another 25bps in June. Hike or no hike, the damage has been done and each additional short-term rate increase at this point just adds more fuel to the fire.

The debt ceiling remains unresolved and is a lose-lose situation for the market. Either the US defaults on the debt (Pandora’s box) or the government comes to an agreement, which would then reverse the entire positive liquidity dynamic from the treasury general account spend that has been witnessed in the markets since November of 2022 (link here for TGA explanation). This reversal would be significant because not only is the liquidity support taken away, but it also acts in reverse as a negative draw on market liquidity, which also simultaneously will work alongside the Fed’s quantitative tightening. Given these forces mentioned above, the market has been quite arduous from both the long and short sides while asset prices have gone vertical for a handful of companies.

Tech Analyst, Ami Joseph responded (link below) to someone who was chirping at him on Twitter (chirping = talking trash). His comment resonated with the setup that I am describing above.

Comment: “NASDAQ up +30% Quad 12345678910”. For the knowledge of the readers, “the quads” are Hedgeye’s proprietary research process and model, so this individual was making fun of them for their negative outlook on certain assets and the economy.

Ami Joseph responds: “I think about this a lot obviously. You have fundamentals deteriorating and assets reflating. It’s a confusing time but closest I can tell with this kind of action, lately it reminds me less of 2001-2002 and more of 1h of 2008 when stocks also rose”.

While I am not referencing this comment to draw any conclusions or analogs to other time periods, I just find it interesting that both of our minds were in a similar space. Below I am going to provide a breakdown, which highlights six of the top ten largest companies in the S&P 500 by weight of the total overall market value of the index.

Apple 7.37% (rank by weight: 1)
MSFT 6.70% (rank by weight: 2)
AMZN 2.95% (rank by weight: 3)
NVDA 2.13% (rank by weight: 4)
GOOGL 2.06% (rank by weight: 5)
META 1.54% (rank by weight: 8)

These companies represent approximately 22.7% of the total S&P 500 market capitalization. The total market cap of the companies above equals approximately $9.2 Trillion. Yes, this is an incredibly large number. Over the last year, these six companies above along with NFLX are +33.57% in aggregate vs. the SPX +1.6% (sideways). When studying the S&P 500 without these Mega-Cap components that everyone is currently chasing, the index is actually down -12.26%. The market and economy are much larger than 6-7 companies.

*Tradingview comparison Mega-Cap Tech vs. S&P 500 vs. Index (S&P 500) without Mega-Cap Stocks

Below I will provide an example of what each of these indexes looks like standing alone.

*Tradingview MSFT+AAPL+GOOGL+META+AMZN+NFLX+NVDA

*Tradingview MSFT+AAPL+GOOGL+META+AMZN+NFLX+NVDA

*Tradingview S&P 500- AAPL-MSFT-AMZN-META-NVDA-GOOGL-NFLX

The divergence between these three charts is crystal clear. As the market has chased Mega-Cap Tech on AI narratives and speculation, the S&P 500 index without those companies continues to slowly deteriorate similar to the economic data that has been previously discussed for a few weeks now. The underlying index is weak and is being supported by six to seven companies, which have the “weight of the world” on their shoulders.

Wrap-Up

Just in case any readers have the expectation for me to be right at every moment in time, I am sorry to disappoint because I am not perfect. As mentioned above, “the game” is incredibly challenging, but incredibly fun to learn and play every day. Over the previous few weeks, we have talked about raising cash on Mega-Cap Tech holdings and managing various short positions. Rarely do asymmetric opportunities present themselves and it is important to take advantage. I will describe my personal actions briefly below.

As market operators and investors, we should not feel the “weight of the world” when making a decision. This should be a natural fluid process, which is fueled by diligent study and the desire to capitalize on potential opportunities. The following is not investment advice but just providing transparency behind my own portfolio management. I have previously spoken about acting incrementally. After writing about raising liquidity on Mega-Cap Tech a few weeks ago, I waited patiently until this week to start executing.

In order to take advantage of a potential asymmetric setup, I sold Mega-Cap Tech out of the long-only account on Tuesday morning into the strength and allocated to some bonds which were trading lower. The majority of the funds from that sale were allocated to a stable cash-yielding fund. Yeah, yeah, yeah, I did not top and bottom tick this one completely, sue me. To my dismay, my employer's 401k options are incredibly limited, so operating within my current parameters.

Within the long/short PA (personal account), I exited my MSFT long position on Thursday at $317.30 (timestamped). Some of those funds were allocated to long Bonds and Gold which have both been trading lower this week. Additionally, I incrementally added more short exposure to capitalize on asymmetry in single stock names. As shown above, the broader market is much weaker than is shown on the surface, so there is individual opportunity in various pockets.

Remember, the market is much larger than 6-7 companies and a reminder for some there are another 493 other companies within the S&P 500 index.

SPX +0.94% (Thursday) and +1.79% week to date
Mega-Cap Index +3.87% (Thursday) and +6.58% week to date
SPX without Mega-Cap -0.28% (Thursday) and +0.15% week to date

Think about a game of Jenga. Toward the end, the entire stack is supported by a handful of blocks. The tower starts to sway as each block is removed. From that point, as each block is removed, the likelihood of the tower completely falling increases significantly. Stay vigilant while 6-7 giants carry the “weight of the world”.

Happy Friday,

Aaron David Garfinkel