Adam Gagas

Chief Investment Officer

October 3, 2023

The S&P 500 Index is often thought of as a proxy for the US stock market. In truth, the S&P 500 is an index that represents only a narrow slice of the domestic marketplace. Recently, the index is showing signs of getting even narrower by two important measures. While investors should be happy to participate in the performance so far, it reinforces our determination to maintain diversification to broader markets.

The 10 largest stocks of the S&P 500 now account for 33% of the value of the index, higher than at any point in the past several decades. Concentration means index returns are determined by the performance of just a few companies. When the list of the largest stocks also includes the best performers in the market, the effect is multiplied. For example, Nvidia (up +198% YTD), Facebook (+150%), and Tesla (+103%) together account for more than three-quarters of the year-to-date advance in the S&P 500 Index.

There is increasing concentration by valuation, as well. Investors are affording the largest companies a higher price/earnings ratio (P/E), indicating a willingness to pay more for every future dollar of earnings. For example, the P/E ratio for the handful of the largest stocks is 27.7, well above the historical average of 20.2. Moreover, that’s higher than the 17.6 assigned to the other 490 stocks in the index.

The same top 10 stocks aren’t contributing a larger share of earnings, however. Despite their above-average proportion in the total index, they are expected to contribute to total earnings in line with historical averages.

When the P (or Price) of the P/E ratio advances at a faster pace than the E (or Earnings) – driving the whole ratio higher – stocks experience “multiple expansion”.  With multiples already 30% higher than historical averages, there may not be room for the P/E to expand.  Future earnings projections will need to climb at a faster pace to justify current valuations.

So, what next? Earnings may accelerate and bring multiples back to historical norms. If not, valuation alone isn’t usually a cause for a decline in stocks, but above-average values may make them more sensitive to shocks. Sometimes stocks simply “tread water” while they grow into valuation. In any event, optimism for perpetual growth isn’t an unusual occurrence, and is the reason diversification into other parts of the market is an important part of well-positioned portfolios.

The word “recession” makes investors feel uneasy and with good reason; the correlation between a bear market and an economic recession is very high. For anyone with money in the stock market, especially those nearing retirement, this can be scary. The “r” word has been making headlines in recent months as investors worry about trade wars, the yield curve inverting, and drops in manufacturing activity. In this piece, we’ll unpack what a recession is, what it means for markets, and what can be done to protect a portfolio against one.

A recession is defined as a period of two consecutive quarters where economic activity declines on an inflation-adjusted basis. The main cause of this is economic activity decreasing; however high inflation and population growth can play a factor as well. For example, Japan has had three recessions in the last 10 years as their population has shrunk by 1.52%.

In the United States, economic activity is measured by the Bureau of Economic Analysis’ calculation of Gross Domestic Product (GDP). This measure takes three months to publish and is then revised each of the next two months before we are given a final reading. Because of the definition and the time it takes to report, we don’t know we’re in a recession until 9 months after it is upon us.

Regarding impact, we analyzed the six recessions we’ve seen over the last 50 years.

For example, in November 1973, a 16-month recession began in the United States which saw GDP shrink by 3.2%. The stock market peaked 11 months prior to the start of the recession (December 1972). It took 21 months to bottom out with a loss of 45.6%. During that time international stocks dropped 29% and five-year government bonds rose 4.5%. Fourteen months after the bottom, a balanced portfolio recovered all it had lost.

A recession’s impact on the market varies. Sometimes the impact is small (the drop we had in Q4 of last year was worse than the market’s reaction in three of the recessions) and other times it is very large. The thing that struck our team was how quickly a balanced portfolio recovers from a recession. A 60% stock portfolio that is diversified among international stocks, and is rebalanced quarterly, recovered on average 9 months after the market bottom. When you’re living through the drop, it can feel like a long time, but for investors whose money has a 30+ year investing horizon, it isn’t that long.

Another thing to remember is we don’t know when/if the next recession is coming. The Wall Street Journal Survey of Economists puts the odds of a recession in 2020 at less than 50%. Australia has gone 28 years since their last recession.

While there is no such thing as an average recession, let’s play one out. Say we begin a recession in January of 2020. We won’t know it’s a recession until next September. The market will have peaked this past July and will drop 31% before bottoming in October of 2020. A diversified 60/40 portfolio will decline 13.3% and recover those losses by July of 2021. Again, it’s not fun, but it’s not the end of the world.

And to reiterate, we don’t know when or if this will happen. We’d bet a lot of money a recession won’t start in January of 2020, not because we think we know what the economy will do, but because it’s a low probability event. In the 48 hours we took to research and write this piece, we’ve had a bit of good data and positive news from trade negotiations. The market is up 2.7% over that time and the headlines talking about a recession have vanished. That could easily change; the only point is that no one knows, and headlines are fickle and sensational.

If the fear of a recession is keeping you up at night, it’s a good idea to reach out to your advisor and discuss your asset allocation. A financial planning best practice is to periodically make sure you’re appropriately allocated for your long-term goals and individual risk tolerance. But alterations that are “short-term” by nature or “tactical” are usually mistakes. As Peter Lynch (one of the most successful investors of all time) once said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” Our job as your fee-only fiduciary advisor is to make sure you don’t prove Peter Lynch right.

Employment in the United States

Employment statistics are considered one of the best (if not the best) indicators of the health of our economy. Last Friday, August 2, the department of labor announced an unemployment rate of 3.7%, slightly higher than the 3.6% in April and May, but essentially the lowest it has been since a 3.5% reading in December of 1969. Most everyone agrees this is positive, though headline unemployment is only one statistic tracked by the department of labor, and probably isn’t the best statistic. In the rest of this piece, we’ll look at where our unemployment statistics come from, and what each of them means as it relates to the health of the economy.

About the Report

To measure unemployment, the government carries out the monthly Current Population Survey (CPS). Each month, the United States Census Bureau contacts approximately 60,000 households, each specifically selected as part of a representative sample of the population of the United States, to be interviewed for the survey. According to the Bureau of Labor Statistics (BLS), highly-trained Census employees “ask about the labor force activities or non-labor force status of the members of these households during the survey reference week.” Some households are contacted four months in a row while others are phased in and out of the survey for shorter periods. In this way, most of the sample is left the same from month to month, to strengthen the reliability of monthly changes in the collected data.

This survey is completely separate from the Establishment Survey which is released at the same time and tells us how many jobs were added each month. In the Establishment Survey, roughly 150,000 employers are contacted by the department of labor to get a sense of the total employment in the United States. The change each month becomes the jobs gained (or lost).

The Unemployment Rate

Over the last 71 years, the unemployment rate has averaged 5.7%, with a low of 2.5% in 1953 and a high of 10.8% in 1982. The current rate of 3.7% is very low by historical standards, with lower readings only observed in 6.7% of surveys. This number tells us what percent of the 60,000 households surveyed said they didn’t have a job and were looking for work. This is a great time to be looking for a job as prospects have improved from the 10.0% reading we saw 10 years ago in 2009.

Labor Force Participation

While this is positive, not all metrics are at 50-year lows. Another number often referenced is the labor force participation rate. A higher participation rate means a greater percentage of the population is looking for work. When this number ticks up, it’s generally viewed as a good thing even if it leads to a higher unemployment rate. Currently, our participation rate is 63.0%, meaning 63% of people age 16 and older are employed or looking for work. This is almost right on top of the average for the last 71 years (62.9%). We saw this number peak in 2000 at 67.3% and bottom in 1954 at 58.1%.

There are two factors that skew this number; the rise of participation by women in the labor force, and people living longer. Women steadily increased their participation from 1948 (32%) to 2000 (60.3%). Since then it has fallen slightly to 57.2%. If you account for this rise and only look at the last 30 years of U.S. Labor Participation you see a bleaker picture. The current 63.0% is near the bottom (62.4% in 2015) and below the 65.4% average of the last 30 years. However, we aren’t accounting for people living longer. Americans living later into their 80s and 90s is a good thing and no one expects them to work (unless they’re in politics).

Employment Ratio

Fortunately, the Bureau of Labor Statistics thought of this and consequently publishes a data set limited to ages 25-54, generally thought of as the prime working years for most Americans. The current rate of 79.5% is a little above normal. Over the last 30 years, we have realized an average of 78.7% with a minimum of 74.8% (2009 & 2010) and a maximum of 81.9% (2000). This better gauge of the current employment situation, the “Employment-Population Ratio: 25-54 Years” ( tells us what percent of working age people are actually working. By not including seniors, it isn’t skewed by people living longer, it also gets around the question of whether workers are discouraged and not actively seeking jobs.

Median Weekly Earnings

Another gauge of the labor market is inflation adjusted weekly earnings. Though hourly wage data is more quoted, we prefer weekly earnings as it takes into account the amount of time worked. If median hourly wages are $100/hour but employers only allow 1 work hour each day, workers won’t have much income to live off. The Bureau of Labor Statistics began tracking weekly wages (for non-supervisory positions) in 1964, when they were $95.50/week. Most recently the number came in at $785.91/week, which seems like a big gain but isn’t because of inflation. If you set 1964 to $1.00/week, and adjust the numbers using the Consumer Price Index (CPI), current weekly earnings stand at $0.99, a bit above the $0.95 average from the past 55 years. The lowest real earnings came in 1996 at $0.84 and the highest was in 1973 at $1.13. Interestingly, earnings peaked right before the crash of 1973 (which saw the S&P 500 drop 48%) and they were the lowest in the lead up to the dot-com boom. Keep in mind, this is a median number that doesn’t include the highest paid members of the workforce. Another thing to note, wages have generally risen while the work week has generally shortened.

Total Wages Being Paid

Overall, the employment situation is very strong. Few people who want jobs aren’t working, and earnings are decent. Some will point to 2000 as a time when the job market was stronger, but on an inflation adjusted basis, earnings are currently 10% higher than they were 19 years ago. Others may point to 1973 as a time when workers were earning more but bear in mind labor was scarcer 46 years ago as less than 44% of women were actively seeking work, and the 25-54 employment ratio was only 71%. The following chart is a metric for total wages being paid as it multiplies the 25-54 employment ratio by an inflation adjusted weekly earnings index. This takes into account inflation and population growth.

Setting the index to 1 in the first year of data, we get a current reading of 1.19, essentially the highest on record. This indicates the labor force is in good shape when accounting for number of people employed and wages being paid. This story shows itself in other data as well; currently there are 7.35 million job openings in America and only 6 million people looking for work. Hopefully the trend of the last decade continues and the American economy stays healthy.

For nearly all investors, the importance of asset allocation and security diversification cannot be overlooked. Diversification can mean different things to investors, but the concept is pretty well understood – hold several different types of investments and you will be better served than those who are concentrated in one stock or in one narrow investment strategy.

I would like to introduce the topic of “tax diversification” here – since it’s not a phrase that is generally understood or discussed among a large percentage of investors and retirees.  The type of account you are eligible to open and maintain will determine how and when the funds are taxed.

For example, whether a withdrawal from your account will affect your taxable income, and ultimately how much you pay in federal and state income taxes depends on the type of account.

Account types generally fall in one of three categories: Tax-Deferred, Tax-Free and Taxable.

  • Tax-Deferred: Funds held in Traditional IRAs, a 401k, 403b, pensions or profit-sharing plans are tax-deferred. Contributions to an employer’s sponsored plan are made on a pre-tax basis before wages are taxed (such as with a 401k or 403b or 457 plan). Most insurance annuities are tax-deferred – gains are taxable when you or a beneficiary receives a withdrawal. In the case of a Traditional IRA, contributions are normally made on a pre-tax basis. Contributions are allowed but complicate the future reporting that is required to avoid paying tax again.
  • Tax-Free: Funds held in Roth IRA’s are tax-free. Contributions to the account are after-tax, but there is no tax charged on earnings or normal distributions. Additionally, certain types of municipal bonds produce tax-free income and may not have to be reported as income on either your state or federal return – or both.
  • Taxable: A typical Brokerage account is taxable. The dividends, interest, capital gains or capital losses are reported to the taxpayer at the end of each year and you will have to pay tax on any income or realized gains. A withdrawal from this type of account are not a taxable event, because tax is paid on the income each year.

When in retirement, there may be compelling reasons to accelerate or delay tax-deferred distributions or rely on those that are deemed tax-free. Rather than simply withdrawing from only one account type, it may make sense to rely on two or even three of those category-types in later years, depending on personal circumstances.  We generally advise our clients, when appropriate and advantageous, to have and maintain a combination of accounts that are “tax-diversified” to maximize the efficiency of distributions, and the favorable tax treatment given to long-term capital gains, dividends and capital losses.  Certain account types are better suited for gifting to individuals or charities during life, while others can more effectively meet philanthropic goals upon death and avoid income tax.

As with many facets of financial planning, there is rarely an absolute right or wrong method, but rather, a better method for distributions, gifts and asset classes held in certain account types. If you believe you stand to benefit from being more “tax-diversified” with your account types, please contact your Rockbridge advisor for a more detailed discussion of this topic.