Markets do not represent the real economy anymore

Analyst Insights, Friday, 10th of July, 2020

One of the reasons why markets have behaved better than the real economy is because the real economy is no longer represented by the market.

For example, 5 stocks are responsible for 23% of the S&P 500 Index. In addition, the first 50 stocks represent about 50% of the Index. And guess what, most of those 50 stocks are technology companies.

Sectors like real estate, malls, airlines, brick and mortar retail, hotels, airlines, and many other sectors do not have a large enough market cap in the S&P Index to play a role. What is driving the market are mostly mega-caps, cloud, software, and semiconductor stocks.

The market cap of the Energy sector has been declining for an entire decade now. Today energy is worth scrap, yet it is responsible for millions of jobs. But it is not represented proportionally to its importance in the Index.

As such, it’s no wonder investors don’t understand why markets are so resilient. Yes, a lot has to do with fiscal and dental bank liquidity, but that’s only part of it.

Another reason is that the multiple in the technology space has been expanding at light speed. I don’t have an answer as to why, and I don’t buy the bullish theories analysts are investing to justify their price targets. In fact, it reminds me of 1999 when analysts were inventing ways to justify why stocks were going up, as opposed to saying valuations were ludicrous.

It’s not surprising that many long-time professional investors are also puzzled, and mostly not invested.