This Isn’t The Global Financial Crisis. And It’s Not The Dotcom Bust.

This Isn’t The Global Financial Crisis. And It’s Not The Dotcom Bust.
Paul Allison, CFA

over 1 year ago4 mins

  • Comparisons between today and the financial crisis or the tech crash are probably misguided. The S&P 500’s in much better shape now than it was during those crises.

  • Today’s largest S&P companies should be much more resilient in the face of macroeconomic headwinds than 2007’s.

  • The current big tech vintage is more profitable and less expensive than 1999’s partying dotcoms.

Comparisons between today and the financial crisis or the tech crash are probably misguided. The S&P 500’s in much better shape now than it was during those crises.

Today’s largest S&P companies should be much more resilient in the face of macroeconomic headwinds than 2007’s.

The current big tech vintage is more profitable and less expensive than 1999’s partying dotcoms.

Mentioned in story

Past bear markets can tell you only so much about the one we’re in now. So, while it’s understandable that investors might nervously stew about the catastrophic losses from the dotcom bust or the global financial crisis, the S&P 500 index isn’t the same as it was back in 1999, or 2007. So for those trying to figure out where and when today’s bear market might end, take a look at how the index has changed…

What’s different about the S&P now?

The S&P 500’s building blocks are fundamentally different. See, the index is capitalization-weighted, meaning the largest companies by value make up the biggest percentage of the index. And it’s the companies and sectors that dominate the index that will drive its profits and price. The chart below shows the S&P’s sector weights today, in 1999 and in 2007.

Source: Forbes

2022 versus 2007

As you can see from the chart, today’s index composition is different from 2007’s: in short, it's less cyclical. And that’s important because it’s cyclical companies that get knocked around the most by macroeconomic headwinds and tend to see the biggest swings in profitability.

Take a look at the deeply cyclical financial and energy sectors, for example: combined, they represented 30% of the index back in 2007, compared to just 15% today. Lob in the materials and industrial sectors, and a full 45% of 2007’s index might be labeled cyclical compared to today’s 26%.

Now compare that to the less-cyclical, higher-growth technology sector. In 2007, tech stocks made up just 16% of the index, compared to 26% today – more than 30% if you include Amazon (AMZN), Meta Platforms (META), and Alphabet (GOOGL / GOOG)

Of course, some technology firms are cyclical (all companies are, to a degree). But the largest tech names – Apple (AAPL, 7% of the S&P 500 today), Microsoft (MSFT, 6%), Alphabet (4%), and Amazon (3%) have proved over time that their profits are less cyclical than the overall market. In fact, with the exception of Microsoft, today's big tech companies actually grew sales and profits throughout the financial crisis. Compare that to the big banks and oil companies that made up a lot of the index back in 2007. Firms like ExxonMobil (XOM) and Chevron (CVX) saw their profits cut in half, while the big banks notched billions in losses.

The takeaway: the big tech companies that dominate today’s S&P 500 should be much more resilient than 2007’s banks and oil companies. Their profit collapse led to a whopping 46% drop in earnings for the overall index. The makeup of today’s index means a repeat of that is unlikely.

2022 versus 1999

If not a 2007 repeat then what about 1999? After all, today’s technology-dominated S&P would seem to resemble its dotcom partying ancestor. But, again, differences are lurking under the surface.

It’s true that in the months before the current bear market, the S&P’s average valuation approached its 1999 heights. But for most companies, including the world’s largest tech firms, valuations fell far short of those rowdy bubble levels. The green line in the chart below shows the forward P/E – that’s price divided by consensus forecast earnings-per-share – of the S&P 500 tech sector. Sure, tech stock valuations were looking punchy last year, but they were nothing like the levels of 1999.

Source: Yardeni Research.
Source: Yardeni Research.

So could the current S&P’s heavily weighted tech stocks suffer more painful valuation contractions? Well, sure, but today’s technology industry is a picture of health in comparison with the wreckage of the early 2000s. Back then, in the aftermath of the crash, investors were questioning the very survival of the technology industry. It’s tough to see a scenario where Microsoft, Apple, or Amazon's existence is drawn into question. These firms are profitable global empires that produce mountains of cash.

The purple line in the chart – the tech sector’s operating profit margins – shows how the tech sector's profitability has improved over the years.

Source: Yardeni Research.
Source: Yardeni Research.

The takeaway: the S&P might look like its 1999 ancestor on the surface, but underneath, today’s big tech stocks are leaner, cheaper, and more profitable than they were back then.

What’s the opportunity then?

Put simply, the S&P 500 is about as profitable as it has ever been. And given those profits hail from less-cyclical, more resilient areas of the market like big tech, if you’re waiting for a repeat of the dotcom era’s huge valuation compression or the financial crisis’s whopping earnings recession, you could get left out in the cold.

Of course, no one can accurately time the market, and we’re not ringing a Finimize buy bell here, but that’s really the whole point. If you keep your eye firmly focused on the longer term and less focused on the scares of the past, now might be a good time to buy.

You can gain exposure to the index by buying ETFs (exchange-traded funds) that are designed to replicate the index, like the Vanguard S&P 500 ETF (ticker: VOO/VUSA/VUAG; expense ratios: 0.03%/0.07%/0.07%).

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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