[Bloomberg Column] S&P 500 Decline Is Not Caused by Trade War

The Recent U.S. Stock Market Decline Is Due to the M7, Not Trump
Not Tariff Fears, but Outlook for Big Tech's Future

Nir Kaiser, Founder of Unison Advisors. Bloomberg

The U.S. stock market is in a state of tension. Recently, as the S&P 500 index entered a 10% correction, investors have expressed concerns, but the highly uncertain policy environment and the unusually strong concentration in top stocks make it difficult to clearly identify what is causing the market instability.

Two issues come to mind. One is visible, and the other is less so. The obvious one is a series of announcements from the White House, some of which directly impact companies, especially in trade policy. Due to the highly tense business environment, even corporate executives who usually avoid political involvement have begun to complain about the Trump administration's economic policies.

The other vulnerability is the large bet on the Magnificent Seven (M7), the big tech companies that make up nearly one-third of the S&P 500. Just as their remarkable growth has lifted the market for years, an economic slowdown will be an obstacle.

However, these two threats are likely to manifest differently. The trade war will disproportionately affect sectors targeted by tariffs such as energy, industrials, materials, and consumer goods. In contrast, a downturn in big tech will directly impact M7 companies like Apple, Microsoft (MS), Nvidia, Amazon, Alphabet, Meta Platforms, and Tesla.

Now consider what happened during the recent market sell-off. All stocks within M7 declined, with a median drop of 14.4%. Losses from M7 accounted for nearly half of the overall decline in the S&P 500. Meanwhile, the rest of the S&P 500 performed better. About a quarter of the S&P 500 stocks rose during this period, and excluding M7, the median decline was 6.6%.

Moreover, the companies targeted in the sell-off were not only those directly affected by tariffs. For example, industrial and consumer goods companies, including automaker Ford Motor and grocery store chain Kroger, made up a significant portion of the profitable firms. Meanwhile, the technology sector, which is best protected from tariffs, showed a downward trend. Verisign was the only tech stock to rise during this period.

Therefore, a closer look suggests that this sell-off appears to be more a prediction about the future of big tech than a fear of tariffs. It is difficult to discern this by looking only at the headline drop of the S&P 500 index. This is mainly because the seven major stocks overshadow the performance of the rest, especially the movements of the smallest 200 to 300 stocks by market capitalization within the index.

The clear focus on big tech may be part of a broader recognition that the economy is slowing and inflation remains above the Federal Reserve's (Fed) 2% target in the U.S. This was acknowledged by Fed Chair Jerome Powell on the 19th. The bond market has been warning of these headwinds. In recent weeks, yields on 2-year and 10-year Treasury notes have fallen, and the 5-year breakeven inflation rate?the difference between nominal and inflation-adjusted yields?has remained near 2.5%, up from 2% last September.

Big tech is not vulnerable to an economic slowdown. On the contrary, their size allows them to better withstand such conditions. However, M7 has recorded astonishingly high growth rates for years. Even adjusting down to a normal growth rate would still represent a significant retreat.

This is bad news for the strong S&P 500 index and likely more important than anything happening in Washington D.C. This is because big tech has driven most of the market's gains for at least the past decade. The Bloomberg Magnificent Seven index, excluding dividends, rose 36% annually from June 2015 through February this year, several times the long-term average market return of about 6% annually since 1928. Removing M7 from the S&P 500 drops the return since 2015 to a modest 5% annually.

Importantly, the surge in M7 is not due to excessive valuations like the 1990s internet stock bubble or the so-called Nifty Fifty (the 50 blue-chip stocks of the late 1960s to early 1970s). Instead, big tech's success stems from an explosion of the most remarkable earnings growth ever recorded. The Magnificent Seven's earnings per share have grown 37% annually since 2015, more than five times the S&P 500's average annual earnings growth since the 1950s. The other stocks also performed well, with an 8% annual earnings growth rate over the same period, but were overshadowed by big tech's formidable growth.

Considering that M7's price gains were driven more by earnings growth than valuation changes, it is reasonable to assume that the recent decline is also earnings-driven, possibly due to lowered growth expectations. This interpretation is supported by the group's valuations. While not cheap, except for Tesla, they are not excessively high. Alphabet trades at about 17 times expected earnings over the next 12 months, Meta at 22 times, and others in the mid-20s range. This is not significantly different from the S&P 500's overall trading multiple of about 20 times.

If the market continues to focus on M7, the S&P 500 index could experience further declines even if many stocks within the index rise. In this case, the index's drop may coincide with the political situation in the U.S. but is largely unrelated to it.

The opposite could also be true. If the trade war intensifies, small and medium-sized companies with low pricing power that cannot pass higher costs onto consumers may be hit. Meanwhile, big tech could simply weather the storm. This time, the S&P 500 index might appear calm even though many companies are struggling.

One thing is certain: a broad market dominated by seven stocks does not accurately reflect the factors affecting stocks.

Nir Kaissar, Founder of Unison Advisors

This article is a translation by Asia Economy of Bloomberg's column "What Spooked the S&P 500? It Wasn’t the Trade War."