A day of reckoning is approaching for the US stock market. The market’s math simply does not add up. The math not adding up was why I recommended to all the readers of my September 2007, Equities Magazine column to get out of the five largest brokers including Lehman, Bear Stearns and Merrill Lynch.
The S&P 500 is extremely vulnerable to a substantial, extended correction that will be caused by the significant decline of FANGAM, an index which is comprised of six of its technology member companies. FANGAM includes the following S&P 500 technology companies:
FANGAM’s six members include the four members of FANG an index which is comprised of Facebook (FB[NGS] – $201.64 Trade ), Amazon (AMZN[NGS] – $1,800.80 Trade ), Netflix (NFLX[NGS] – $314.66 Trade ) and Google (GOOGL[NGS] – $1,304.09 Trade ). Apple (AAPL[NGS] – $267.25 Trade ) was included in FANGAM because it’s a member of FAANG, another index derivative of FANG. Microsoft (MSFT[NGS] – $151.38 Trade ) is a member of FANGAM since it’s a technology company and its market cap is the third highest, only behind Apple and Amazon.
Key statistics for FANGAM as compared to the S&P 500 for the 12 months ended September 1, 2018:
- Market cap increased at a compound annual growth rate (CAGR) of 42% versus 15% for the S&P 500 and 40% for FANG.
- Accounted for 17% of the S&P 500’s market cap.
- Produced 37% of the S&P 500’s gains.
By the sheer laws of mathematics and gravity, the heady performance of FANGAM is unsustainable. FANGAM’s six members have created a Catch 22 for the S&P 500. Should the market cap of FANGAM:
- decline or even cease to grow, the performance of the S&P 500 will be negatively impacted. The index has become completely dependent on FANGAM’s members to reach new highs.
- continue to increase, the market caps of S&P 500’s remaining 494 members would have to decline. The amount of money that can be invested in stocks is finite. Throughout any period in the S&P 500’s entire history, which encompasses secular bull and bear markets, the index has never grown at double digits.
The market cap CAGR of 42% for FANGAM for its 12 months ended September 1, 2018 is out of control when compared to the growth of its fundamentals. For the latest fiscal-year the revenue of FANGAM increased by 19%. FANGAM’s five-year CAGR comparisons are much more realistic; market cap growth of 28.9% compared to its revenue growth of 36.4%.
The chart below depicts the CAGRs for the market caps of FANGAM’s members for their latest 12 months and five years ended September 1, 2018. The CAGR growth rates for all of FANGAM’s members for their latest 12 months exceeded their five-year CAGR growth rates.
The chart below depicts the CAGRs for the market caps and the revenue of all of FANGAM’s members for the five years ended June 30, 2018. The CAGR for the market caps for five of the members exceeded their CAGRs for their revenue. Facebook was the only exception. e.
The chart below depicts CAGRs for the market caps and revenue of all of FANGAM’s members for the 12 months ended June 30, 2018. The market cap CAGR for all of the six members with the exception being Facebook exceeded the CAGR of their revenue.
Based on the disparity between FANGAM’s CAGRs for its market cap and revenue, there are only two things that can happen:
- The revenue growth for FANGAM and its members accelerates to the same or a higher rate of growth than FANGAM’s market cap. This is not likely to happen due to the law of large numbers and especially because of the law’s application to a business. According to the law, the larger a business grows, the more difficult it becomes for the business to accelerate or even maintain its revenue. See Investopedia “Law of Large Numbers and Business Growth”. Since FANGAM had aggregated revenue of $681 billion for its latest fiscal year, it qualifies for having large numbers. Therefore; the probability that FANGAM can accelerate or even maintain its present growth rate is remote.
- The rate of growth for FANGAM’s market cap declines to the growth rate of its revenue. The probability is high that this will happen. Investors paying a substantial premium for a business over its revenue growth rate is a temporary anomaly. Upon a significant decline in FANGAM’s market cap, the CAGR for its market cap over its past five-years will fall sharply and swiftly. Facebook’s one-year chart below for September of 2017 through September of 2018 is a good example of this phenomenon which will happen for FANGAM’s other five members and the S&P 500. The chart depicts a paper loss for most of the investors who purchased Facebook shares over the last 12 months. Since June 2018, Facebook’s five-year CAGR for its market cap has declined from 55% to 37% due to its share price correcting.
Those who believe that the market is not bound by gravity might argue that the growth of the S&P 500’s market cap could accelerate to the growth rate of FANGAM’s market cap. However, based on the available empirical data, it’s not possible for the market cap of the S&P 500 to grow at a CAGR that is anything close to FANGAM’s.
For my empirical research, I utilized the index’s data which dates back to 1928, when the S&P 500 was founded. From 1928 through 2018, the S&P 500 grew at a CAGR of 5.82%. The S&P 500 reached 4.43, its low over the last 90 years in June of 1932, which was also its post-crash 1929 low. Assuming that one invested at the S&P’s 1932 bottom, the CAGR was 7.75% as of September 1, 2018.
The table below depicts the performance of the S&P 500 for select periods of nine years or more since 1928. All periods in excess of nine years resulted in the S&P 500 increasing at a CAGR rate which was below 7.75%. The nine-year periods of double-digit returns were followed by secular bears which resulted in average high single digit returns over multiple decade periods.
The reason why the stock market for any and every developed and emerging country has a single digit growth rate ceiling is because the growth rates of economies and stock markets are directly related to population growth and inflation. The highest growth rate for the US population since the 1950s was just below 2%. Since 1913 the average rate of inflation in the US is 3.18%.
The charts of Japan’s and the US’ populations and projections for 1950 through 2050 as well as the performance of their respective stock markets from 1980 to 2018, shown below, further support why the S&P 500 cannot produce double digital returns for investors over the long term.
The chart below depicts that the S&P 500 increased by 9.2% during the 38-year period, which includes 27 years of secular bull markets and 11 years of secular bear markets.
This chart below depicts that Japan’s working age population peaked in the late 1980s and its total population peaked after 2000.
The chart below depicts that the all-time high for Japan’s Nikkei 225 stock index occurred in 1989. This coincided with the peak of Japan’s working age population. From 1980 to 2018, Japan’s Nikkei produced a CAGR of 3.3%. From its 1989 peak to 2018, the CAGR for the Nikkei was -1.91%.
The bottom line is that the math for FANGAM and the S&P 500 does not add up. Based on the market cap of the S&P 500’s CAGR increasing by 15.62% since the current bull market began in 2009, the market caps of FANGAM and the S&P 500 indices have no room to grow. The S&P 500’s long-term long trend line which is based on population growth and inflation will revert to back to its mean. That can only happen by the index declining by a minimum of 60% and the S&P 500 growing at a subdued rate for a period of 10 to 20 years. This period that the S&P 500 will soon enter is also known as a secular bear market. For information about secular bull and bear markets and the type of investments that I recommend during a secular bear market go to my website BullsnBears.com.
To better understand my math and also to learn about secular bull and bear markets and the recession investing strategies that I am recommending from now through 2030, watch my recently taped two-part interview which will air on the Fox Business Channel during the second half of October. A private and pre-screening of my interview is exclusively available to alert subscribers. Click here to subscribe to BullsNBears.com free alerts.
Below are my most recent must-read articles which pertain to the market being at high risk for a significant correction or a crash:
- Perfect Storm Brewing for Possible Market Crash Next Week, October 5, 2018
- Market Vulnerable due to Buyback Blackout; Bull & Bear Tracker signal now Red , October 4, 2018
- Nobel Laureate Shiller says Current Market is Eerily similar to late 1920s, October 4, 2018
- Frenzied Market Blow Off Underway, October 3, 2018
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