Why This Rally Is More Broad And Sustainable

| About: SPDR S&P (SPY)

With the S&P 500 (NYSEARCA:SPY) reaching a new nominal high of 1569.19 last Thursday, it is a common practice to look back at previous market highs to attempt to glean whether or not the market will be able to extend its rally.

As I did at the recent Dow peak in early March, I plan to author a number of articles that examine the current valuation of the broad market gauge versus past historical peaks. The first article in this miniseries was published on Friday, and demonstrates that the S&P 500, while at a new nominal high, is still 22% below its inflation adjusted peak reached in August 2000.

As we fast forward back to the market's current new nominal peak, one important characteristic of this most recent market rally has been how broad it has been across industries. As seen in the chart below, the two previous peaks were characterized by outsized gains in certain market sectors. In March 2000, when the market hit its then peak of 1527.46 during the height of the tech bubble, the S&P 500 Information Technology subindex (NYSEARCA:XLK) constituted 34.5% of the index's capitalization. In October 2007, just five months before the failure of Bear Stearns and eleven months before the failure of Lehman Brothers, financials (NYSEARCA:XLF) contributed 20.1% of the S&P 500 Index at its then peak of 1565.15.

Source: Standard and Poor's, Bloomberg

The advance today is much more broad as seven different sectors make up at least ten percent of the index capitalization with no sector making up more than twenty percent. There is no obvious sector where excesses have dominated the market's advance, which hearkened the past harsh corrections in tech and financials. Unsurprisingly, healthcare (NYSEARCA:XLV) has become a larger portion of the index as our population ages and healthcare inflation continues to outpace the rise in other prices. Not only has this market advance been more broad based, but the market appears more conservatively valued at this new nominal peak. Below is the price/trailing twelve month earnings of each industry subindex today versus the last two peaks.

Source: Standard and Poor's, Bloomberg

Market bears would counter that this rally has not been driven by an individual sector, but the broad, and potentially perverting, influence of extraordinary monetary accommodation which has lifted the price of assets broadly by reducing the discount rate. While I am somewhat sympathetic to this sentiment and believe that investors should stay diligent about emerging risks, I think additional gains are ahead for the domestic equity market. I do caution investors to not get too complacent in this new lower volatility paradigm. Market drawdowns of five percent or more occur on average five times per year, and we have not seen a correction of this magnitude since November. While we do not know what lies ahead for the equity market, we do know that the market excesses that plagued individual industries at past market peaks do not appear to be present today. Look for coming articles that compare various market multiples and valuation metrics today versus previous market apexes.

Disclosure: I am long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.