One of the things I enjoy most about being in the financial industry is the exceptionally smart people I meet. I have often talked about the changes in our economy, the emergence of new industries, and the kinds of new jobs that are created as a result. We are hearing of a “jobless recovery” without looking deeper into the longer-term picture. I have been fortunate to have Erik Cannon, a rising third-year student at Lafayette College doing research regarding the changes to the S&P 500 over the years. What follows is his excellent work.
While created as an indicator of broad market returns, the S&P 500 is also viewed as one of the top leading indicators of future economic activity since its creation in the mid-twentieth century. It is seen to be the most reliable gauge of prospective business and consumer confidence levels. The changes in this index often define the age that we are living in, and it can be used to determine the direction of the future of economic growth. Periods of high S&P 500 returns are often correlated with strong economic performance such as in the 1980s when the S&P 500 rallied after the 1981-1982 recession caused by rising oil prices and a high rate of inflation. In 1973-1974 the S&P 500 saw two very poor years of performance as a result of recessions caused by sharply rising oil process. This was followed by a period of strong market results and an improved economy.
The composition of the S&P 500 also has much to tell about the economic engines of our economy. The information revolution in the late 1970’s led to the growth of technology based companies such as IBM and AT&T Inc. ($T) in the 1980’s. While they were the two largest components of the S&P during that time, they did not solely define that decade. As major industrial countries of the world faced petroleum shortages, the result was sharply higher oil prices. As a result, natural resource companies such as Exxon Mobile Corporation ($XOM) and Royal Dutch Shell plc ($RDS.A) established themselves and became a large portion of the S&P index during this decade. In fact, seven out of the 10 largest components of the S&P 500 in 1980 were natural resource-related companies.
The 1990s Bring a Global Economic Boom
The 1990s were a transformative period for worldwide economy. Many of the largest companies in the S&P 500 companies were multi-national companies, such as General Electric Company ($GE), Phillip Morris International Inc. ($PM), The Coca-Cola Co. ($KO) and IBM ($IBM) took advantage of a rise in the more global nature of world economies. Later in the decade, the Internet era began and we saw prominent technology companies such as Microsoft Corporation ($MS), Intel Corporation ($INTC) and Cisco Systems Inc. ($CSCO) (all in the top 10 in the S&P 500) rise during this time. Many other Internet companies emerged and surged to become major components of the S&P. An excessive amount of investing in low quality internet companies in the late 1990s led to the bursting of the technology bubble in the early 2000s. The bursting of that bubble led investors to choose more high quality, and blue-chip companies with a more established track record and financial strength. As a result, mature companies such as Johnson & Johnson ($JNJ), General Electric and Pfizer ($PFE) garnered large market shares of the index.
The bursting of the Internet bubble has taken us to where we are today. Currently there is confidence in the S&P 500 and in turn the US economy as we see investors pouring billions of dollars into exchange traded and mutual funds that track this index. While the price to earnings ratio of the S&P 500 is high and interest rates low, company earnings are relatively strong, coupled with the improving employment picture, as the rates of unemployment and inflation are low. While stocks are priced high relative to historical averages, with the factors just mentioned, it is an environment where those prices are considered to be reasonable. When we saw high stock prices relative to earnings in the late 1990s, it was largely due to small internet companies with low earnings causing the tech bubble and later bursting.
A Prosperous Present, but an Uncertain Future
But this does not mean that the future of America is bright and the S&P will continue to rise. The Federal Reserve is going to increase interest rates later this year, and there is concern about the impact that it will have. In the recent past (2014), when the Federal Reserve has mentioned raising the interest rates, we have seen the S&P react negatively.
With low interest rates, people really have few options for return but to invest in the stock market. But with higher interest rates, there could be less investment in stocks as bond yields and bank account rates would rise, providing investment alternatives to investors. This could have a negative impact on stock prices.
There is also uncertainty in the global economy because of the Greek debt crisis. If Greece defaults on their debt then it will negatively impact Europe, and in turn the global economy. The recent slowdown in China can be attributed to the economic weakness in Europe, caused by Greece. If Greece does default on their debt, then it could push the world economy into a financial crisis. With so much uncertainty in the near future, it is difficult to be overly optimistic or pessimistic about where the economy and the stock markets are headed. While times are good now, our decade will be defined by the decisions that are made in the coming months.
By Jordan Kimmel, Chief Investment Officer at Investview, Inc. (INVU).
Note: I use my own Magnet Stock Selection Process to assess companies. I am not an analyst, nor do I make buy or sell recommendations. I always suggest investors do their own research.
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