Following the Global Financial Crisis of 2008 and the stock market meltdown that ensued, the S&P 500 crashed to a low of 666 in March 2009. Since then, the index has been steadily climbing with moderate volatility and scaled 3,300 in January 2020. Then, triggered by the COVID-19 crisis it crashed to around 2,200 in March. From the lows of March, the index has climbed sharply by around 60 percent and is hovering around 3,600 now. S&P 500 has doubled during the last 5 years and tripled during the last 10 years. From the lows of March 2009, the index has multiplied around 5 times. This is an excellent performance. S&P 500 ETF investors have gained substantially. Even investors in emerging markets like India who invested in international funds floated by the domestic mutual funds have benefited handsomely.
Six stocks are driving the S&P rally
It is important to understand the anatomy of this bull-run in S&P 500. The Index appreciation conceals a lot more than what it reveals. During the last 5 years, the FAANGM – Facebook, Apple, Amazon, Netflix, Google and Microsoft - stocks appreciated around 400 percent while the rest of the S&P 500 crawled up only by 40 percent. It was this huge outperformance by the FAANGM stocks that gave S&P investors handsome gains. Why did the FAANGM stocks gallop during this 5-year period? Their phenomenal growth and super-tech status warranted premium valuations. But, importantly, these stocks outperformed on earnings growth justifying the lofty valuations to a large extent. Earnings of FAANGM grew 100 percent while the earnings of the rest of S&P 500 grew in pedestrian low-single digits during this period. In the long-run stock prices are slaves of earnings.
25 companies generate 70 percent of India Inc's profits
Which brings us to a similar trend in India. Analysis of corporate profitability in India reveals wide variation among sectors. Some sectors like financials, IT, energy, commodities and consumer goods are doing exceedingly well. These 5 sectors account for around 70 percent of India Inc's profit pool. And in each of these sectors, there are a few companies that generate around 75 percent of profits of the sector. 25 companies in these 5 sectors account for 50 percent of the profits of India Inc. Therefore, for earnings growth, investors need to focus on these 25 companies, which are only 0.5 percent of listed stocks in India. It is important to appreciate the fact that earnings of these companies are likely to sustain. In other words, investment in the top companies in these segments would continue to be a rewarding experience, in spite of their high valuations.
However, better market performance may come from some dark horses in some other sectors, which are not that big. Mid-small-cap companies in niche segments can emerge as multibaggers. But, for the majority of retail investors, it would be difficult to identify such potential winners. Therefore, the ideal investment strategy to play this segment would be to invest through mutual funds.
In brief, investors should remain invested in blue chips in the performing sectors, go for some geographical diversification by investing in global stocks/ international funds and invest in the blue chips of tomorrow by investing in mid-small-caps through the mutual fund route.
(VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.)