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Jeremy Owens: Hello and welcome to OnWatch by MarketWatch. I’m Jeremy Owens. I’m excited to bring you the first episode of our new weekly financial news podcast that will look to bring you our in-depth coverage of the financial markets, economy and personal finance every Thursday. Each week we’re going to break down complex news from the latest moves in bond yields to the emergence of artificial intelligence, while also helping you tackle the most important personal finance issues of the day. Whether it’s updating you on the latest tax brackets or the age-old debate of renting versus buying, we are OnWatch, so you know what to look out for.
As an introduction to myself, I’ve been MarketWatch’s tech editor and San Francisco Bureau Chief for the past eight years, looking at the performance of publicly traded companies. Basically, I’ve been chasing the billions that Silicon Valley has produced in the past decade and today in our first segment, we’re going to get into how you as an investor should think about the current landscape of corporate profit. Then we’ll help you set yourself up for financial success this year with tips from one of our MarketWatch columnists, who also happens to be a certified financial planner. Plus we’ll take a quick look at the news stories we are watching right now and how they’ll affect your wallet. First, let’s talk about a dramatic change in corporate America’s profits, one that many people may not have noticed.
I’ve covered corporate earnings for nearly a decade, and there’s one thing I really need you to know about it. The largest companies in America are making money in a way we’ve never seen before, and this goes beyond what you hear from reporters like myself every year, when we shout record company earnings to get your attention. Honestly, any large group of companies should produce record earnings every year. That’s why the S&P 500 through index funds has become one of the most popular investments in America. The risk of investing in a single company that could have a very bad year or fall apart is evened out by pairing it with other companies that could suddenly boom or just get record earnings the easy way, increase revenue, while at least maintaining how much you keep from every dollar of sales. Now it’s that last part, known as a profit margin, that changed dramatically for the S&P 500. Large companies are keeping more of each dollar of sales as profit since the COVID-19 pandemic than we have ever experienced in history.
Elevated profit margins of the S&P 500 is the core reason that the stock market has recaptured its record highs. While we await final 2023 financial results, should be flooding in the next few weeks and leading to many of those record earnings headlines. So how did this sudden growth in profit margin happen and what does it mean for the future of the stock market? Let’s walk through it. When margins grew amid decades high inflation in 2021, there were loud accusations of greedflation. It’s when companies increased prices solely to pad their bank account. Many of the CEOs said they were increasing prices to prepare for promised wage increases and growing costs amid supply chain challenges.
The numbers actually show there was some truth to that. Margins have come down since 2021 in sectors like consumer staples, which includes grocery stores and other companies that sell essential goods to Americans, and they declined to overall for the S&P 500 for six consecutive quarters through the middle of last year. That’s when two things happened that rescued corporate America’s record profit and set the market on a new path. Tech layoffs and a rocket ship named NVIDIA.
Tens of thousands of layoffs at big tech companies turbocharged their bottom lines and they turned around and used that cash to buy NVIDIA’s artificial intelligence enabling hardware in massive numbers, and at massive prices. The S&P 500’s profit rebounded and so did the index, which added nearly $8 trillion to its valuation last year on the wings of AI hype. Which brings us to right about now and what all this means for the market moving forward. If you think about the S&P 500 as a giant ship with all 500 companies on board to help run it, what we have right now is just seven of those companies steering the ship. The rest, they’re just along for the ride.
These captains of the SS S&P 500 are Google parent Alphabet, Amazon, Apple, Facebook parent Meta Platforms, Microsoft, NVIDIA, and Tesla. They’ve been described as the magnificent seven by many news organizations, but I’m not in the business of routinely describing Facebook and Elon Musk as magnificent. Fortunately for me, there’s a common thread among this group. They are the only U.S. companies that have ever been valued at a trillion dollars by the public markets. I call them the trillionaires.
To say these companies are dominating the S&P 500 is a giant understatement. Last year, their collective valuation gained more than $5 trillion. Compare that to the S&P 500’s valuation gain of less than $8 trillion. That means the trillionaires were responsible for roughly 65% of the Index’s market cap gain last year, despite comprising just 1.4% of its components. But doesn’t this go against the main reason behind investing in S&P 500 index funds? Wouldn’t the entire index be susceptible to a massive drop if just one of these seven companies failed?
To discuss this, I called up Phil Van Dorn. Phil writes MarketWatch’s Deep Dive investing column and he recently joined me to talk about these issues and what investors should make of what’s now the trillionaires’ market. So Phil, I’ve learned a lot from you since I’ve been at MarketWatch, and the biggest thing is an intense focus on the S&P 500 because so many people are invested in index funds for the S&P 500. So I wanted to ask you just how a typical American who’s invested in those index funds should think about these developments.
Phil Van Dorn: Well, I like index funds because they spread out your risk over many stocks and because the expenses are so low. In the mutual fund industry, traditionally, you might be looking at expenses of 1% of assets under management per year, and that can really pile up over time. But with an S&P 500 Index Fund, your expenses get close to zero. But as you have mentioned when you called the group of expensive stocks the Trillionaires’ Club, a small group of companies now make up between 27 and 30% of the S&P 500 depending on which day you look at it.
Jeremy Owens: Right, so that’s seven out of 500 companies accounting for more than a quarter or less than a third of the entire market cap of the S&P 500 and really swaying the underlying metrics. What should an investor kind of take from this and how should we look at the S&P 500 moving forward, knowing how much these companies matter?
Phil Van Dorn: One can say that there’s a heck of a lot of risk in the seven companies that make up only 1% of the S&P 500, but make up close to a third of its value. However, the S&P 500 is self-correcting. It rewards success. A company such as NVIDIA, which popped last year because it essentially dominated a new category of important tech products, is taking up a much larger portion of the index than it did before. Over time, if that changes, its weighting will go down and other companies’ weightings will go up, presumably as they take market share from NVIDIA. That’s only one example. But if you’re pouring money in, over a very long period of time, to build a retirement nest egg by having a portion of your earnings invested automatically in the stock market, the S&P 500 is a wonderful way to diversify those holdings and to get in on the action, when certain companies have runaway success.
Jeremy Owens: What we’re seeing right now is good for those investors. In general, a higher profit margin is a good thing for investors in an individual company, is an even better thing for investors in the entire S&P 500 when we’ve seen that those kinds of gains in profit margins.
Phil Van Dorn: The S&P 500’s net income margin, which is earnings divided by sales, has been in a generally positive direction improving for many years. That benefits all investors, because a higher profit margin supports higher stock prices. As we look across the board, we’ve seen improving margins for many large companies and that is in part because of the increasing efficiency over the long term, that we’re seeing from the adoption of cloud technologies and other technologies.
Jeremy Owens: Very high margin technologies, by the way. Cloud computing has gigantic margins.
Phil Van Dorn: Yeah, it’s fascinating, but keep in mind, in any given year, you may not see your account value rise very much. Last year was a great year for the stock market. The S&P 500 is only up slightly since the end of 2001. It’s up about 5%. So you had a big seesaw in 2022, 2023, and that is why your objectives must drive your investment decisions. If you’re in for the very long term, based on decades of history, you can count on a 10% average return annually for the S&P 500, but in any given year it could go down 50%. You never know. So it has to be for long-term.
Jeremy Owens: There is a flip side, with the dominance of these seven companies, and that’s if they don’t do what they’re expected to do, it could flip the entire S&P 500. They are expected to continue to grow earnings. Despite how fast NVIDIA grew last year, they’re expected to grow earnings yet again in the coming year. But all of this is based on hopes for AI, especially when we look at Microsoft and NVIDIA. Facebook and Google definitely are pushing along those as well. We are going to see just a ton more chatbots this year. They are trying to make them better and help companies run more efficiently. But on the other hand, are consumers going to want to use those chatbots? Just making them more capable doesn’t necessarily mean that people are going to like that format, like doing that instead of trying to call and get a human on the phone.
Phil Van Dorn: I think they’re going to love it. If we could type in a little question and have it answered in 10 seconds, that’s much better than making a phone call, in a world where companies don’t answer the phone any longer. So I disagree with you on that one.
Jeremy Owens: Yeah, we’re going to have to see how that plays out. It sounds like all of this makes you even more positive on the S&P 500 and where it’s headed, Phil, that the potential downside doesn’t really scare you that much, that it’s more about the strong price earnings ratio now and a potentially positive future.
Phil Van Dorn: One can argue at any time that stocks are too expensive and you might be right, but if you’re putting money in steadily when the market drops, you pay a lower price, you scale in lower as prices drop and it can work out over time. Time in the market beats market timing. We’ve seen that time and time again. If you wait on the sidelines because valuations look too high, then after the market falls and then begins to recover, you will return too late. Investors who try to time the market typically return too late, miss out on a portion of the recovery and have lower long-term returns over time.
Jeremy Owens: Well, that’s a lot to think about as we move forward, Phil. So thank you so much for coming on and helping us understand this.
Phil Van Dorn: Thanks, Jeremy.
Jeremy Owens: We’re going to take a quick break. Coming up, personal finance tips for 2024. Stay with us.
Welcome back to OnWatch by MarketWatch. Before the break, we talked with Phil Van Dorn about the stock market, but many American investors turned away from stocks last year. Instead, they chose to invest in a market that has been largely dormant for 15 years. As the Federal Reserve increased interest rates to combat inflation, savings vehicles that had fallen out of favor through years of low interest rates such as treasury bonds and certificates of deposit known as CDs suddenly became popular again. With the Fed expected to cut interest rates at some point this year, there’s been a rush to jump into these investments before rates fall lower. However, MarketWatch’s personal finance columnist and certified financial planner, Beth Pinsker has reported that many people are reluctant to lock in those rates. We spoke with her about that hesitancy and how to think about investing this year, along with other tips and tricks for making 2024 as prosperous as possible.
So Beth, when we’re talking about planning for finances in 2024, the first thing that really came to my mind is the biggest overarching question in finance right now, which is where we’re headed on interest rates. How this will affect normal people putting their money where they’re going to anytime is if they’re going to lock it into interest bearing type accounts, which people have been very interested in throughout 2023, bonds and certificates of deposits or CDs have been very popular. These are long-term lock-ins that give you interest rates and are very safe. Because of the rise in interest rates last year, we saw them more. Could you explain exactly what they are and why people are so interested in them right now, Beth?
Beth Pinsker: Yeah, nobody born after the year 1980 knows what the CD is, but those of us who are a little older, remember them.
Jeremy Owens: Hey, born in 78 here and I knew exactly what a CD is. I remember the nineties, okay, so yeah, I’m there with you.
Beth Pinsker: Okay. They haven’t been used very much in the last 10 years, because the interest rates haven’t been good. But CDs are good for people who have intermediate term savings that they want a higher interest rate on. Typically, CD rates are just slightly above what a high yield savings account would give you. But these days, interest rates are kind of all over the place and short-term rates are the highest right now, while medium term rates like two, three years are somewhere just below that, and then long-term rates like 10 years are even lower, but they bounce around. So it’s hard to pin down exactly where the best rate is unless you keep track of the charts and most people don’t. That’s why CDs are coming back into popularity is because people want to do better than a bank account. But everything else is too complicated.
Jeremy Owens: Yeah, people are worried that we’re at a peak interest rate environment right now and it’s only going to come down from here. Want to go ahead and lock in those rates is basically the best way to put it.
Beth Pinsker: So putting money in a CD is basically about as easy as putting it in a bank account.
Jeremy Owens: With the one main difference being that you can’t pull it back out at any time. You lock into a certain term before you can get that money back. Whereas a high-yield savings account, you have access to it whenever you need it.
Beth Pinsker: Exactly. You don’t have to go to a special website, like for treasury bills. You don’t have to buy anything at auction. You don’t have to worry about having a brokerage account or anything like that. You can do it from a bank, you can shop online. You can pick a bank that’s offering a good rate, but just be aware of the terms and conditions that come with that, because there are some complicated offers out there and that aren’t always in your best interest.
Jeremy Owens: If someone is looking to lock in these interest rates before the fed cuts, how should they be mentally walking through that?
Beth Pinsker: Well, you may already be too late. No matter how much people shout from the rooftops that were at the peak of interest rates, regular people don’t seem to be listening. They seem to be afraid of locking in. The problem that experts say you’re going to come across down the road is that you’re going to then be locked out. If you want 5% now and you’re willing to hold out for it, what are you going to feel like when it’s 3%?
Jeremy Owens: We’ve seen interest rates, especially on CDs, come down this month even below 5%. That’s a big thing for people to realize and think about as they’re moving their money into different places, right?
Beth Pinsker: So what you want to do is have a conversation with your future self three years from now and three years from now, if interest rates are at two and a half on CDs and even lower on high yield savings accounts, how are you going to feel if you have your long-term savings at 5%? I would think you’d feel pretty good. That would seem like you did the right thing. Now how are you going to feel if interest rates are at 2.5% and you didn’t lock in? You’re only going to be making 2.5%. This money, what we’re talking about is… This is sort of like your garage freezer emergency savings.
Your real emergency savings, the money that you need for fixing your tire if it blows out for immediately, you need to keep that in a more liquid form than a CD or a treasury or something that even has a three to six month maturity. So that’s sort of like your deep freeze money. Your money for two years from now and three years from now. You don’t need to keep that in a high yield savings account making the market rate. You can put that into a longer term instrument that is relatively risk-free and still is earning the top rate of today. You just are mitigating your risk of it earning the top rate of tomorrow.
Jeremy Owens: There’s a combination here of rates and terms. It’s not just look for the rate. It’s if you find a high rate, well, what are the terms that are helping that high rate? It’s a balancing act there in trying to determine where you should put that money.
Beth Pinsker: Right, and if you’re shopping around and you’re being really aggressive about chasing the highest yield product on a CD or whatever bond you’re looking at, you really have to be careful about the terms, because a lot of the really high offers come with terms that are going to bite you on the back end. So they might have high withdrawal fees, they might have call features, which is when the bank decides that it’s going to pay you off and you don’t really have any choice in the matter, because that’s one of the terms of the deal that you signed. So if interest rates shift, the banks might want those CDs back and you’ll have to take your money and figure out what to do with it then. The rates might not be as good as what you intended to sign up for. So your 7% CD might go away if it’s callable. Banks are hungry for customers, they need new money, and one of the ways they’re getting it right now is by offering really high rates with various conditions. The house always wins.
Jeremy Owens: Beth, those are great tips for jumping on these interest rates in 2024. There are other people though, just made a New Year’s resolution more generally about being more financially responsible this year. Beth, what else do you suggest people think about as we head into 2024 and how to set up their financial lives for success this year?
Beth Pinsker: I think the most important thing that people can do is focus on what they care about and what they want to do with the money that they’re earning and saving. Because without the purpose of it, what are you doing? Money has a purpose. Money is a tool. Money is not a means to itself. So if all you’re focusing on is 4.9% versus 5%, the $90 or whatever you’re not going to get in 2024, if you miss the window of opportunity to get the higher rate, what does that mean for you? It’s not about the chase, it’s not about the return. It’s about what you’re doing with that money. So that’s why I think people’s personal New Year’s resolutions should be a bigger think about what they really want out of their circumstances in life.
Jeremy Owens: Great. Well, thank you so much for joining us, Beth, and we’ll talk to you again soon.
Beth Pinsker: Thanks.
Jeremy Owens: Before we go, it’s time for what we are watching, a look at the news you need to know for the rest of the week and beyond. That flood of holiday season earnings reports are on the way, which will give us the final results for last year. Now next week, Tesla, Netflix, AT&T, Intel and about 75 other S&P 500 companies are expected to reveal quarterly results. That’ll launch the heart of earnings season, so be sure to check MarketWatch for what you need to know from those results. But earnings aren’t the only way, we find out what happened in the holiday season. U.S. retail sales data was released Wednesday and showed sales jumped about 0.6% in December, beating economists’ expectations. Now retail sales account for roughly a third of all consumer spending. The latest figure points to a sustained resilience in that spending. That may mean the Federal Reserve will hold off on cutting rates for a while.
Some say the continued strength in economic indicators suggests the threat of a recession is in the rearview mirror. Soon we’ll get another of those indicators. U.S. GDP for the fourth quarter will be announced next week on Thursday. We’ll break down that reading and more next week.
That’s it for this episode of the show. Thanks to Phil Van Dorn and Beth Pinsker. To keep following the latest on corporate earnings and personal finance tips, head to MarketWatch.com, where you can also read a companion piece I wrote for this episode that dives deeper into the numbers behind the trillionaires’ growing power and what they’re doing to corporate profit margins. OnWatch is a podcast from MarketWatch. You can subscribe to the show wherever you get your podcasts, and please do. If you like what you heard, please leave us a rating or review. It really helps others discover the show and let us know what you want to hear from us. You can reach us at onwatch@marketwatch.com, and if you’re a listener on Spotify, be sure to answer this week’s Q&A on the topics you want to hear more about. The show is hosted by me, Jeremy Owens, and produced by Meadow Lutzhaft and Katie Ferguson, who also mixed this episode. Melissa Haggerty is the executive producer. We’ll be back next week with a new episode and until then we’ll be OnWatch.