The Path to Flat

The S&P 500 is down 3.9% this year and the Dow is down 6.9%, which is bad to the bone. It’s pretty hard to retire on negative portfolio growth. But fear not. We’ve got 70 trading days left. What would it take to get the indexes back to flat, and beyond?

This was the question studied by Nicholas Colas and Jessica Rabe of Convergex on Tuesday, and they came up with an interesting answer. They disassembled the S&P 500 into sectors and determined how much each would have to go up to make a dent on the deficit.

The results:

— Just getting the Financials sector back to flat (it is currently down 5.4% YTD) wouldn’t do it. At a 17% weighting in the S&P 500, that would only be 0.9% incremental performance. Even if Financials end the year up 10%, that would only add another 1.7%.

— Energy, down 19.8% YTD, is a logical place to hope for a bounce, but even if that sector rallied all the way back to flat for 2015 in one day, its current 7% weighting would only go to 9%, and still leave the index down on the year.

— The one sector that can make the difference is technology, which at a 20% weight in the S&P 500, could most easily push the market back into black for the year. Tech is currently down 1.1%; get the group to +10% on the year AND get Financials up 10%, and you’re basically back to flat.

— In short, it has to be a combination of sectors, and it would be best if two led the way.

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So what sectors and stocks are in fact leading the way? The Convergex analysts note:

— The S&P 500 is up 5.9% since the August 25 lows. The groups that have led are technology (+8.4%), energy (+7.3%), consumer discretionary (+6.8%) and industrials (+6.5%). Not utilities, which are lower by 0.4%. Health care is surprisingly lagging, up only 5.1%.

— Eight of the biggest 11 companies by market cap, amounting to 20% of the entire index, have outperformed the S&P 500 since the late August lows. The biggest helpers: Apple (up 12.1%), Google (up 9.1%), Microsoft (up 8.7%), ExxonMobil (up 6.6%), GE (up 8.7%), Wells Fargo (up 6.9%), JP Morgan (up 6.9%), and Amazon (up 12.0%).

— Underperformers among the top 11 mega-caps have included Johnson & Johnson, up 4%, and Berkshire Hathaway, up 2.6%.

Now here is the Convergex recipe for a good final kick higher for the market:

— Tech must reverse its -1.1% ytd performance and rally 20% from here.

— Financials must reverse their -5.4% ytd loss and rally 23%.

— Energy must reverse its 20% ytd loss and rally more than 25%.

The bottom line here, in case it’s not clear, is that while it might seem easy to get back to flat, in fact a lot of convicted buyers have to come in hard and fast. We would need to see a reversal of analyst expectations for a tepid Q4 and 2016 and see confidence for tech spending by businesses and consumers, some stabilization in China, stabilization in crude oil prices and an abatement of uncertainty about the course of interest rate hikes by the Fed.

The good news? Convergex observes that the average one-year forward P/E of the top 11 stocks in the S&P 500 is just 14.5x, which is unchallenging, and their average dividend yield is 2.2%. Those kinds of statistics explain why they led the bounce from late August, note the analysts. Propelling the index from here will be a lot harder.

Best wishes,

Jon Markman