The New Nifty Fifty + Peak Reopening and Is Stock Leadership Rotating from Large Growth to Small Value?

Commentary

The New Nifty Fifty + Peak Reopening And Is Stock Leadership Rotating from Large Growth to Small Value?

KEY TAKEAWAYS • Today’s largest stocks bear a striking resemblance to—and in some ways differ markedly from—yesteryear’s Nifty Fifty. Jurrien Timmer • At the same time, we may be seeing a rotation in market leadership, albeit perhaps Director of Global Macro paused, from large cap growth to small cap value stocks. Fidelity Global Asset Allocation • I see the economy as near “peak reopening,” and I think the stock market is near “peak rate of change,” i.e., continued growth but at a diminishing rate. • At some point, the Federal Reserve may need to decide whether to intervene or to allow real yields to be set by the capital markets.

Nifty Fifty Redux With large cap growth stocks back in the lead in recent weeks—propelling the S&P 500 to fresh all-time highs in the process—I figured now would be a good time to take a look at what I’ll call the new Nifty Fifty. (For those who’ve forgotten, the original Nifty Fifty were a handful of high-growth blue chips of the 1960s and ‘70s that withstood even the vicious 1973–1974 bear market.) I entertained this topic last summer, but a lot has happened since then. We can get a sense of similarity among historical patterns by comparing, in percentage terms, the relative return of the S&P 500’s 50 largest stocks (by market capitalization) versus the remaining 450 over time (Exhibit 1). The data shows that, over the long term, mega cap stocks have tended to lag the market, presumably because they have by and large been a bit ... boring: quality stocks with high price-earnings (P/E) ratios and steady but unexciting earnings growth. But interspersed along that declining trendline have been a few periods of notable mega cap leadership. EXHIBIT 1: Mega caps may lag, but when they’ve led, they’ve led. The original Nifty Fifty era consisted of so-called S&P 500’s Top 50 versus Bottom 450 Stocks, 1962–2020 one-decision stocks (i.e., bought, not sold), while the 1990s’ dot-com tech stock boom and bubble ran S&P 50 vs. 450 Trendline +20% +30% +35% afoul of “irrational exuberance.” Current mega cap Relative Performance 1.40 dominance has, I think, been driven largely by demand for free cash flow (FCF) in a world of slow growth and low interest rates, which seems to me something somewhat different from either of the prior episodes.

0.70 I think it’s still too early to tell, but this current era may have come to an end last fall. Following the 2020 U.S. presidential vote, many market observers sensed a new secular regime of coordinated (some might say activist) fiscal and monetary policy. With this shift, 0.35 1962 1972 1982 1992 2002 2012 2021 combined with the post-peak pandemic reopening of the economy, mega caps took a fairly decisive turn S&P 500’s top 50 and bottom 450 stocks as ranked by market capitalization. in relative return. From election day 2020 through Shaded bars indicate recessions. Source: Fidelity Investments, with special thanks to Fidelity senior market data analyst Sam Houston-Read; monthly the end of March 2021, the S&P’s top 50 largest data, rebalanced monthly, as of 4/30/21. stocks underperformed the bottom 450 by around 15 percentage points—after having outperformed by close to 50 points since 2014. The leftward section of Exhibit 1 charts the original The new Nifty Fifty made up roughly 55% of the Nifty Fifty era, the middle shows the dot-com bubble, S&P 500’s total market cap at the end of March 2021 and towards the right we have the current regime. (Exhibit 2), down from this cycle’s peak of about 58%. The constituency has changed over time—and there was never any “official” list—but a surprising number of agreed-upon nifty have survived, including AT&T, EXHIBIT 2: Have Nifty Fifty Fortunes Turned? Johnson & Johnson, and what is now Citigroup. S&P 500 Top 50 versus Bottom 450 Stocks And while recent leadership has been dominated S&P 50 vs. 500 S&P 450 vs. 500 by Microsoft and the FAANGs (Facebook, Amazon, Percent of Market Cap Apple, Netflix and Google/Alphabet), 1972’s Nifty 70% 67% 66% Fifty, topped by IBM, included many digital and electronics companies—along with several “techs” 60% 60% 58% 57% of the times, innovators such as Xerox, Eastman 55% 54% Kodak, General Electric, and, further outside the 52% box, American Express, 3M, and, of course, The Walt 50%

Disney Company (which has always striven to stay 47% 46% ahead of its time). Nor have consumer desires changed 43% 45% all that much. Today’s mobile devices, while marvelous, 40% 42% 39% deliver the same functions prioritized in 1972: 33% 34% telephone (AT&T), TV (GE), camera (Kodak), computer 30% power (IBM), and shopping portal (Walmart). 1962 1972 1982 1992 2002 2012 2021 Shaded bars indicate recession. Top and bottom stocks ranked by market The mega cap growth environment in place since 2014 capitalization. Source: Fidelity Investments; monthly data, monthly rebalance, is the third such regime in six decades. 1/1/62–3/31/21.

The New Nifty Fifty + Peak Reopening | 2 That high was just shy of the 60% seen in 2000 and is that mega caps’ outperformance since 2014 was well shy of 1973’s 66% max. Sector-wise, at peak the supported by an (almost) equally strong gain in relative “growthier” sectors made up 72% of the top 50 largest earnings. So, one might argue that, unlike what was stocks and only 30% of the bottom 450, percentages happening in 1998–2000, current mega cap leadership well in line with the 2000 extreme. On the flip side, has been justified by improving fundamentals and, if the more value-oriented sectors represented a mere so, may prove more sustainable. 10% of the top 50 while making up 52% of the bottom Of course, this doesn’t tell us whether or not the new 450. (By definition, all three iterations of the Nifty Nifty Fifty’s six-year dominance ended a few months Fifty have been growth-oriented, but I am using the back but it at least says to me we might not be in value/growth categorizations broadly because what the midst of a full-on valuation bubble. This in turn is considered growth today—technology, health care, suggests to me that even if the market is undergoing communication services—is not necessarily what was a secular shift toward small cap and value stocks, considered growth 50 years ago.) we may well avoid a repeat of mega cap growth’s While in terms of overall performance and sector catastrophic underperformance that followed the 2000 composition today’s Nifty Fifty look a lot like the peak. Without the havoc of a bursting valuation bubble, high-fliers of the late 1990s, the two eras exhibit quite I think we could potentially enjoy a smoother ride on different relative valuations. Back in 2000, the S&P’s the way to value and small cap stock leadership. 50 largest stocks traded at 40.5 times earnings while So, where might we find ourselves in the size/style the bottom 450 traded at a much lower P/E of 19.9x. rotation? Taking the secular bull markets of 1949–1968 That gap closed completely, though, during the 53% and 1982–2000 as analogs, I believe we may have bear-market downdraft created by the tech bubble’s reached the broader market’s “peak rate of change,” implosion (Exhibit 3). meaning the market may continue to climb but do Compare those figures with what we saw this past so at a diminishing rate. When I run the data, I see March: The S&P’s top 50 stocks traded at about a 30x evidence of a slowing second-order derivative within P/E multiple while the bottom 450 traded at a P/E of long-term uptrends; if my view is correct, the current 31x: no huge gap this time around. My conclusion cycle may represent more of a “rising tide lifts all boats” dynamic than something from the zero-sum days of the early 2000s.

EXHIBIT 3: Reality may be less warped than one might think. And, indeed, I think that view fits with the market S&P Top 50 versus Bottom 450: P/E and Performance environment of these past few months: a broadening tape where some styles and sectors do better than S&P 50 vs. 450, Total Return P/E Premium (Discount) Trendline others (same as ever), but this time without a lot of 120% 1.40 total-market blood in the streets (Exhibit 4).

80% Peak reopening? Despite all the foregoing, mega caps have reasserted 40% 0.70 leadership over the past few weeks, which may have hit pause on the rotation from large growth to small 0% value. This change raises the important question of whether the market has fully discounted the post-

-40% 0.35 pandemic economic grand reopening. Remember: 1962 1972 1982 1992 2002 2012 2021 Getting the cycle “right” is not just about having

Shaded bars indicate recession. Source: Fidelity Investments; monthly data, a sense of what should come next but also of the monthly rebalance, 1/1/62–3/31/21. information reflected in the market’s price.

The New Nifty Fifty + Peak Reopening | 3 EXHIBIT 4: Recent events have not unraveled absolute returns. The top panel of Exhibit 5 shows equity size and style Large Cap Growth and Value Equity Performance changes, in terms of relative performance, over the past couple of years. The bottom panel shows the Russell 1000 Growth Russell 1000 Value S&P 500 Federal Bank of NY’s weekly economic index (WEI)— S&P 500 Index an aggregate of various economic indicators—which has done a complete roundtrip from lockdown to reopen. In retrospect, the reopen trade a few months ago appears to me to have been perfectly discounted 3400 by the market. Add in rising inflation expectations and the question is, where do we go from here? I don’t know the answer of course, but based on casual observation, I suspect a lot of positive economic news may now be reflected in the stock market. While anecdote ≠ data, I have found airports to be bustling, 1700 restaurant reservations harder to come by, and Nov 2019 May 2020 Nov 2020 May 2021 colleagues and acquaintances eagerly returning to Source: Bloomberg Finance L.P., Fidelity Investments; daily data, social (albeit socially distanced!) activities. Cities that 8/28/19–4/7/21. a year ago were all but ghost towns appear, thankfully, brimming with new life, resurrected along with jobs and earnings expectations. EXHIBIT 5: Can economic trends maintain momentum? Taking positive changes in expected earnings into Economic and Equity Size and Style Trends account and layering decreasing unemployment claims onto the WEI shows some unsurprising Size: R2000 / S&P 500 (YoY) Style: Value / Growth (YoY) U.S. 10-Year TIPS Breakeven WEI Weekly Change economic interconnectedness (Exhibit 6), but Relative Performance also suggests to me the rate of change for bond 35.6 40 33.5 yields, inflation breakevens, and sector/style

20 17.6 rotations may be peaking. 16.2 Speaking of earnings, 2021’s first-quarter earnings 0 %-pts season has been tremendous, with a tentative final 2.8 -20 4.9 5 -22.4 tally of 86% of companies reporting a positive earnings 2.5 2.4 surprise, which, according to FactSet, very likely has -40 -38.0 2.0 set an S&P record. Normally, estimates start too high 1.6 0 and over time drift lower, but at major bottoms the -0.5 1.2 opposite happens: Estimates start too low and need 0.8 to be revised higher, which is what we have been 0.5 -4.4 -5 0.4 witnessing of late. In fact, the current cycle looks to Jan 2019 Oct 2019 Jul 2020 Apr 2021 me very much like 2010’s follow-on from the mid-2009 earnings bottom of the global financial crisis (GFC). R2000: Russell 2000 Index. Value: Russell 1000 Value Index. Growth: Russell 1000 Growth Index. The Weekly Economic Index (WEI) published The S&P 500 forward earnings estimate, as of the end by the Federal Reserve Bank of NY (FRBNY) comprises 10 economic of May 2021, sits higher than the peak set in February indicators covering consumer behavior, labor markets, and production. The breakeven rate measures the spread between 10-year Treasuries and 2020 just before COVID-19 changed our lives. Data TIPS; a widening spread indicates higher inflation expectations. %-pts: also indicates that companies have been growing percentage points. Source: Federal Reserve Bank of NY, Bloomberg Finance L.P., Fidelity Investments; weekly data through 5/22/21. more confident about buying back their stock.

The New Nifty Fifty + Peak Reopening | 4 EXHIBIT 6: The post-pandemic economy may be nearing peak reopening. Economic Statistics of Crisis and Recovery

Jobless Claims FRBNY Weekly Economic Index WEI Weekly Change

6,000

4,500

3,000

1,500 Percent 473 0 14 8 4.4 11.4 7 4

-7 -4 -4.4 -11.4 -14 -8 Mar 2018 Sept 2018 Mar 2019 Sept 2019 Mar 2020 Sept 2020 Mar 2021

For WEI weekly change, percent indicates percentage points. Source: Federal Reserve Bank of NY, Department of Labor, Bloomberg Finance L.P.; weekly data through 5/13/21.

At the same time, massive amounts of money market cash parked on the sidelines—peaking just above $4.6 trillion in Q2 2020, according to the Fed—have been stubbornly gyrating around the $4.5 trillion mark as late as mid-May 2021 (although I have wondered whether this apparent inaction could partly be the product of stimulus checks looking for a home). So, have we reached “peak reopening?” By this I don’t mean that the reopening itself has peaked but that the rate of change in reopening momentum has leveled off. (In my experience, inflection points almost always are about changes in the second derivative.) If the answer is yes, then it makes sense for the size/style rotation to take a rest, and it makes equal sense for bonds to find a bid, however temporary. As of 6/1/21, yields on 10-year Treasuries were down 13 basis points from their 2021 high of 1.75%. Will yields eventually resume their uptrend, heading to 2% and beyond? I think possibly yes, especially if markets come to believe that inflation is making a secular comeback. Money supply measurements suggest to me some potential cause for concern (Exhibit 7). Subtracting the effects of inflation on the money supply allows us to compare our current situation with other time frames, most notably the World War II period. Economists debate the relationship between money supply and inflation, but I think some general tendencies make themselves apparent. And regardless of past interplay, the rate and magnitude of the Fed’s current money supply expansion is unprecedented, even as its effects are yet unclear. I’ll note that the flip in the stock-bond correlation back in 1964—from positive to negative—did not end the secular bull market for stocks until four years later. High inflation is what can kill a bull market, and inflation didn’t really take off until the mid-1970s, and, despite any historical observations, in my view we still seem a ways away from anything similar.

The New Nifty Fifty + Peak Reopening | 5 EXHIBIT 7: Mirage, or is inflation on the horizon for real this time? Liquidity Growth and Inflation

CPI (10-Year CAGR) M2 minus CPI (YoY) M2 minus CPI (10-Year CAGR) Trendline

10%

0% 30% 27%

21% 20% -5%

8.3% 10% 3.4% 6.7% 0%

-10% 1896 1906 1916 1926 1936 1946 1956 1966 1976 1986 1996 2006 2016

Shaded bars indicate recession. CPI: Consumer Price Index. CAGR: compound annual growth rate. YoY: year over year. M2: a broad measure of the U.S. money supply. S&P 500 monthly total return versus the monthly change in the real yield. Source: Bloomberg Finance, L.P., Haver Analytics, Fidelity Investments; monthly data, 1/1/37–2/15/21.

EXHIBIT 8: Remember, the trend is not always your friend. Trends in World Population, U.S. Interest Rates, and Debt/GDP

10-Year Treasury Yield 5-Year Change in the Global Working-Age Population Wu-Xia/FRBA Shadow (Real) Fed Funds Rate U.S. Budget Deﬁcit/GDP

4 8 8

0 0 0 -8

-8 -8 -24 1962 1972 1982 1992 2002 2012 2022 2032 2042 2052

The Wu-Xia shadow federal funds rate is a theoretical construct, unconstrained by the zero lower bound, intended to provide a more accurate measure of U.S. monetary policy than the nominal federal funds rate; see appendix for more information. FRBA: Federal Reserve Bank of Atlanta. GDP: U.S. gross domestic product. Source: Federal Reserve Bank of Atlanta, FactSet, Haver Analytics, Fidelity Investments; monthly data, 1870–2021.

The New Nifty Fifty + Peak Reopening | 6 Further, whatever level of inflation policymakers may generate through rampant money printing, it will need to overcome stiff secular deflationary headwinds. Exhibit 8 shows the 10-year Treasury yield overlayed onto the 5-year growth rate for the global labor force. The chart also includes an estimate of the federal funds “real” rate (called a “shadow rate”), which attempts to account for unconventional monetary policy and, unlike the nominal fed funds rate, can go negative. The track of the U.S. annual budget deficit as a percentage of GDP provides additional food for thought. Quantitative easing and deficits notwithstanding, demographics are a big deflationary hurdle to overcome. (For a deep dive on these aspects, please see Fidelity research reports “Unsustainable Global Debt” and “Rising Policy and Political Risk.”) So, if we have indeed reached “peak reopening,” then I would not be shocked were a bull- market breather headed our way. This is not my base case, and I don’t think a mild correction would change my overall views. But, as always, past performance is no guarantee of future results, and also as always, history can rhyme even if it doesn’t repeat. With those caveats, I find it worth noting that the two market-cycle analogs that have to this point charted very closely with the current situation faced a correction at this stage. In terms of price and earnings bottoms, I think the GFC timeline has tracked our current market experience very closely (Exhibit 9). Note that after a 74% gain from March 2009 to April 2010, the market fell 17% over the summer of 2010 before returning to the path of the bull.

EXHIBIT 9: Amid the global financial crisis, the bull stumbled but did not fall. S&P 500 Real Returns

Real S&P Price Gain: 2020 LTM EPS Growth (from price low): 2020 Real S&P Price Gain: 2009 LTM EPS Growth (from price low): 2009 110%

84% 74%

55%

40%

20% 0%

-17% -20% Mar 2019 Sept 2019 Mar 2020 Sept 2020 Mar 2021 Mar 2008 Sept 2008 Mar 2009 Sept 2009 Mar 2010 Sept 2010 Mar 2011

S&P 500 real price gain is price appreciation net of inflation. LTM: last 12 months. EPS: earnings per share. Source: Bloomberg Finance L.P., Fidelity Investments; weekly data.

The New Nifty Fifty + Peak Reopening | 7 EXHIBIT 10: Here, too, the bull took a stumble but not a tumble. S&P 500 Real Returns during World War II

Real S&P Price Gain (Gold): 2020 Real 5-Year (TIPS Yield): 2020 Real S&P Price Gain (CPI): 1942 Real 10-Year (5-Year CPI): 1942 80% 80%

60% 54% 53%

40%

20% 1.5 0% 0.0

-1.83 -1.5 -1.98 -2.64 -3.0 Mar 19 Sept 19 Mar 20 Sept 20 Mar 21 -2.98 Apr 41 Oct 41 Apr 42 Oct 42 Apr 43 Oct 43 Apr 44 Oct 44 Apr 45

S&P 500 real price gain is price appreciation either net of inflation or in ratio to the gold price, as indicated. LTM: last 12 months. Real interest rates are net either of the TIPS yield or of inflation, as indicated. CPI: Consumer Price Index. Source: Bloomberg Finance L.P., Fidelity Investments; weekly data.

What tripped things up a bit, I think, was that the Federal Reserve called a halt to QE1, its initial round of quantitative easing, which may have a parallel in the market’s recent obsession with when the Fed might start tapering its current asset-purchase operations. I believe the 2010 mid-cycle correction was not about fundamentals but about fear of evaporating liquidity. The same may hold true today. The second example is related to World War II (Exhibit 10), which has been my go-to analog for more than a year now. I think that line of history aligns very well with the fiscal/monetary regime we find ourselves in today. After a 53% gain in real terms, the S&P 500 fell 13% from July 1943 to November 1943. This, of course, set us up for a long upward run, but the reasons are more than we have space for here. Will history repeat itself? I really don’t know; history is a guide, not a guarantee. But after a 90% S&P gain in 13 months plus the possibility of a “peak reopening” plateau, I think it would be naïve to act surprised if the bull market—or the size/style rotation, or both—might like a break to rest and regroup.

The New Nifty Fifty + Peak Reopening | 8 Information provided in this document is for informational and educational purposes only. To the extent any investment information in this material is deemed to be a recommendation, it is not meant to be impartial investment advice or advice in a fiduciary capacity and is not intended to be used as a primary basis for you or your client’s investment decisions. Fidelity and its representatives may have a conflict of interest in the products or services mentioned in this material because they have a financial interest in them, and receive compensation, directly or indirectly, in connection with the management, distribution, and/or servicing of these products or services, including Fidelity funds, certain third-party funds and products, and certain investment services. Regarding the Wu-Xia shadow federal funds rate: Unlike the observed short-term (nominal) interest rate, the shadow rate—first introduced by Fischer Black (1995)—is not restricted from moving below 0% (the “zero lower bound”). Cynthia Wu and Fan Dora Xia’s model uses a broad range of macroeconomic factors and econometric techniques to develop a statistical estimate of the effective, or real, federal funds rate. This shadow rate can help develop a more accurate assessment of economic conditions and facilitate trend analysis. For details, see “Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower Bound” (2015), Chicago Booth Research Paper No. 13-77, available at SSRN: https://ssrn.com/abstract=2321323. The stocks mentioned here are not necessarily holdings invested in by FMR LLC. References to specific companies should not be construed as a recommendation or investment advice. 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