Six months ago, the most widely followed index in the US, the S&P 500, was down 34% from its peak. Today it has not only recovered from all its losses, but also managed to hit new record highs having rallied more than 55% from its trough. Investors betting against this market have been crushed, leaving short positions at their lowest level in more than a decade. The speed and velocity of this recovery have also been exceptional. By way of comparison, during the 2008 Great Financial Crisis, it took four years to recover all the losses from the lows and almost five years to recover from the dot.com bubble sell-off. 

But the record high on the S&P 500 does not explain the full story of this market recovery. While Tech and Consumer Discretionary stocks are up 28.6% and 23.1% year to date (YTD) respectively, Energy and Financials stocks are down 41% and 21.2%. That is probably the most uneven recovery we have seen throughout history. Today the FAAMG stocks (Facebook, Apple, Amazon, Microsoft, and Google) represent 24% of the S&P 500’s $29.77 trillion market cap. A 5% rally in Apple alone contributes 0.35% to the S&P 500. In short, the S&P 500 no longer represents the 500 largest US companies but instead a handful of Tech stocks. That also means performance on the index will be vulnerable to any correction in these big names.

From a valuation perspective, the Tech titans are way overvalued compared to the index. Apple, Microsoft, and Alphabet are all trading at a forward price-to-earnings (PE) multiple above 30, Facebook is slightly below 30, while the outlier Amazon is trading at a forward PE of 83. But if we exclude these five big behemoths, the S&P 500 is only on a forward multiple of 20. While the overall index might look cheap when compared to these Tech firms, it has never traded above this multiple since 2002.

Monetary and fiscal policies may justify overstretched valuations for an extended period of time. With interest rates near zero and long-term rates expected to remain at current low levels, investors have few options to choose from and that’s why Tech firms are enjoying the limelight. However, if other sectors do not start catching up, this would send a very alarming signal.  If interest rates explained the full story, then Japan’s stocks should have been outperforming all their major peers, but that’s not the case.

Economic activity is nowhere near its pre-pandemic levels and so far, we have no clue on when a Covid-19 vaccine will arrive, and if it does arrive when the mass population will be vaccinated. The US election is another risk looming with only 70 days remaining to the big day on November 3. These risks need to be taken into consideration if one still wants to participate in this most uneven of bull markets.

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