The stock market, as measured by certain indexes, is very close to all-time highs. Recently, however, a large number of well-known names have plunged. Many of them are technology related and have been among the most overpriced stocks. The list includes LinkedIn (NYSE:LNKD)(down 31% year-to-date), Twitter (NYSE:TWTR) (down 50% YTD), Netflix (NASDAQ:NFLX), and Tesla (NASDAQ:TSLA) (each down about 28% from their March highs). Of course, not all technology stocks were overpriced. Those that offered value have held up well. Apple (NASDAQ:AAPL), which even pays a nice dividend, is up 25% YTD.
What is happening, however, is that there is a rotation going on. Investors have been moving away from stocks that have little or no earnings in favor of stocks that offer more value. Perhaps nothing exemplifies this rotation better than the relative performances of Staples (NASDAQ:SPLS) and Amazon.com (NASDAQ:AMZN). Take a look at the chart below. (Source: Google Finance). It shows how these two stocks have performed since my March 17 post explaining why I was buying Staples and avoiding Amazon. As seen on the graph, Staples has rallied 15% while Amazon has plunged 22%.
Even though investors have come to their senses about valuation, there is still a lot to be worried about. The Dow Jones Industrial Average and the S&P 500 Index are near all-time highs, but most stocks (which are smaller and not included in these indexes) have been performing poorly. The Dow is price weighted and the S&P 500 is market-cap weighted, yet they don't include many of the high-priced, large-cap stocks that have suffered big losses. For example, neither index includes LinkedIn, Twitter, or Tesla. However, Amazon and Netflix are included in the S&P 500, yet so is Apple. Indeed, as the largest-cap company in the index, Apple gets much of the credit for holding up the S&P 500.
I clearly remember back in the 1990s how stocks were rallying strongly. However, as valuations started getting out of hand toward the end of the decade, something began to change. The indexes kept going higher, but most stocks were breaking down. It turns out that the indexes were being driven by the largest names. In fact, if you had removed just 50 of the largest stocks from the S&P 500, you would have seen that the index was actually falling.
Something similar may be going on now. However, there is one big difference between today and the late 1990s. Back then, investors could sell stocks, rotate into fixed-income, and still get a decent return. These days, with interest rates so low, that's not a realistic alternative. These days, investors may still sell stocks, but they are more likely to rotate into cheaper stocks than into bonds.
Disclosure: Author is long SPLS