Why Cyclical vs. Secular Stock Market Trends Explain the 2023 Bull Market

The Magnificent 20 Vs. the Mediocre 480

I WISH EACH AND EVERYONE OF YOU SUPPORTING THIS SUBSTACK A HAPPY NEW YEAR. CAN’T THANK YOU ENOUGH.

PETER

Why Cyclical vs. Secular Stock Market Trends Explain the 2023 Bull Market

Confounding a whole slew of otherwise smart people running literally trillions of dollars in hedge and pension funds, the US stock market, as measured by total return of the S&P 500, finished in spectacular fashion in 2023 while posting an annual gain of 27% (including both dividends and price appreciation.)

In the wake of this seeming inexplicable Biden Bull, the passive investor, buy and hold crowd crowed that anybody who “plays the market” is a fool; and the only thing for us retail investors to do is just buy and hold broad market indices for years on end and just let your broker worry about it.

Fair enough – if you just look at the results of this year.  But perhaps not so smart if you take a little bit of time to unravel the mystery of just what bus hit so many in the hedge fund crowd who took massive, often times leveraged, shorts of the S&P 500.

So let me take a crack at trying to unravel that mystery for you – which you will see turns out to be no mystery at all.  The “culprits” such as they are in the murder of the shorts are two.

The first was a massive movement of funds from a far larger bond market into the S&P 500 beginning at the end of October when both inflation and the yields on bonds across the yield curve began to decline and all of the chatter about the Federal Reserve cutting rates aggressively in 2024 began. 

Seeing this phenomenon, and believing that the prognostications were correct – that remains to be seen – investors hitherto worried about being caught in a bear market and enjoying relatively robust bond yields reversed course.  These bond market refugees took at least some of the bond money and sought higher equity returns. 

Of course, as the bullish trend quickly took hold, that sucked in more and more money from bonds into the S&P 500.  This helped propel it on its historic climb up the wall of worry to where we are now.

Yet, this is only half, and maybe less than a third, of the whole story behind the 2023 unexpected bull market.  The rest of the story lies in understanding the critical difference between short term cyclical market movements and longer term secular trends that are far more resilient to cyclical pressures.

To flesh this out, a good portion of the S&P 500 moves cyclically up and down with the course of economic growth and expansion and recession in the economy.  Logically, most companies tend to make more money when growth is good and less when growth is slow or negative.  Since stock prices are simply an expectation of a future stream of earnings, rosy economic projections augur upward moves in the market and bullish trends.

Secular trends transcend the business cycle and can propel companies up or down over long periods of time as technology changes.  For example, with the advent of the automobile, the horse and buggy industry went into a long term secular decline until the industry was extinct.

On the other, we are now in the midst of one of the most profound technological and structural shifts in our nation’s economic history.  This secular trend is being propelled by the advent of artificial intelligence engines and more generally the power of technology to move information and improve both efficiency and productivity.

And here’s our punch line: It was precisely this long term secular trend propelled by technological change in general, and the emergence of artificial intelligence engines in particular, that has accounted for an astonishing high proportion of the S&P 500’s 2023 rise from what looked to be the bearish ashes of a pernicious inflation-rising interest rate cycle.

This secular punch is illustrated in one single statistic.  As reported by the Financial Times, just 20 tech stocks accounted for fully 90% of the S&P 500’s $2.36 trillion gain. 

Moreover, the lion’s share of this gain was attributable by the so-called Magnificent 7 mega cap tech stocks Apple (AAPL), Amazon (AMZN), Alphabet (GOOG, GOOGL), Nvidia (NVDA), Meta Platforms (META), Microsoft (MSFT) and Tesla (TSLA).

That statistic alone provides an excellent rebuttal to the passive investor crowd.  If you were smart enough to focus on those 20 tech stocks, or just the Magnificent 7, you would have blown any passive investment in the S&P 500 out of the water.

Of course, another way to say this is if you were dumb enough to miss the Tech 20 explosion and got stuck with shares of stock in the rest of the Biden economy – which is to say the shares of over 400 of the 500 stocks in the S&P 500, you would have likely deeply regretted not grabbing the high bond yields available.

And I think that is my punchline: If a very large fraction of individual stocks in the S&P 500 had a modest, sluggish, or down 2023 because of the Rube Goldberg Biden economy and its inflation and soaring interest rates, that should serve as a cautionary and sobering note to investors in 2024.