View from the Observation Deck
 
For today’s post, we compare the delinquency rate on consumer loans issued by all U.S. commercial banks to the prices of the S&P 500 Consumer Discretionary Index, over time. We use data from the Board of Governors of the Federal Reserve System, retrieved from FRED, for the former set of observations.

At 42.30%, the S&P 500 Consumer Discretionary Index (Consumer Discretionary Index) boasted the third-highest total return of the 11 major sectors that comprise the S&P 500 Index in 2023. The Consumer Discretionary Index has not fared as well in 2024, posting a year-to-date (YTD) total return of 4.10% thru 6/25/24.

With a total return of -3.93%, Real Estate is the only sector in the S&P 500 Index with a lower total return than consumer discretionary stocks YTD through 6/25/24. Consumer spending appears to be weakening, which has had an impact on U.S. GDP. Data from the Federal Reserve Bank of St. Louis reveals that consumer spending (as measured by Personal Consumption Expenditures) has comprised 67.7% of U.S. GDP, on average, since the end of 2006. Notably, real GDP growth was revised downward from 1.6% to a tepid 1.3% in Q1’24, led by a decline in personal consumption and slower growth in inventories. Core sales, which are crucial for estimating GDP, were up just 0.1% on an annualized rate through the first five months of 2024 while sales at restaurants and bars were down 2.3% on an annualized rate over the same period, according to Brian Wesbury, Chief Economist at First Trust Portfolios, LP.

As revealed in today’s chart, after falling to an all-time low of 1.53% in Q3’21, the consumer loan delinquency rate surged to 2.68% at the end of Q1’24. Loan delinquency rates among credit cards and auto loans have risen as well. 

One important aspect of overall consumer health is the rate at which they are defaulting on their debt obligations. To be sure, not all delinquencies will become defaults, but a spike in the number of payments that are past-due could be an indication that the U.S. consumer is under increasing financial duress. The loan delinquency rate for credit cards issued by all insured commercial banks stood at 3.16% at the end of Q1’24, its highest level since the close of Q4’11. In addition, S&P Global reported that the percentage of U.S. auto loan delinquencies rose to 3.32% in 2023, marking the highest level for the metric since at least 2013.

Takeaway: The delinquency rate on consumer loans issued by all U.S. commercial banks, stood at 2.68% at the end of Q1’24. At current readings, delinquency rates are well below their historical average of 3.07% and even further below their all-time high of 4.85%. That said, the recent surge in delinquencies is notable and does appear to be a trend. Given their sizeable contribution to GDP, we maintain that a healthy U.S. consumer may play an integral role in the U.S. avoiding an economic recession. We will continue to monitor the delinquency rate among consumers and report on changes.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Consumer Discretionary Index is an unmanaged index which includes the stocks in the consumer discretionary sector of the S&P 500 Index. The S&P 500 Index is a capitalization-weighted index comprised of 500 stocks used to measure large-cap U.S. stock market performance. Consumer delinquency data is seasonally adjusted.

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View from the Observation Deck  

Today's blog post compares the performance of energy-related stocks to the broader market, as measured by the S&P 500 Index, over an extended period. Given that most developed and developing economies are dependent on oil, natural gas, and electricity for their growth, the prices of those commodities often (but not always) influence the valuations of companies involved in those sectors. Click here to view our last post on this topic.

The S&P 500 Energy Index (Energy Index) underperformed the broader S&P 500 Index in seven of the eight time frames represented in today’s table. For comparison, the S&P 500 Utilities Index (Utilities Index) underperformed the S&P 500 Index in all eight of the periods.

In a previous post, we noted that energy company valuations frequently exhibit a high correlation to the price movements of their underlying commodity, while the valuations of utilities companies often fluctuate based on prevailing interest rates. From our perspective, the recent total returns of energy and utility stocks continue to reflect these associations, with some caveats being applied to recent utility valuations. The price of a barrel of WTI crude oil rose by 12.67% YTD through 6/21/24. For comparison, the S&P 500 Energy Index increased by 8.04% on a total return basis over the same period (see table). By contrast, the Utilities Index increased by 10.57% despite no change to the federal funds target rate over the time frame. While it is true that natural gas and electricity prices have increased, surging demand for electricity, resulting from increased usage of Artificial Intelligence (AI) may offer a more compelling explanation for the recent increase in utility stock valuations, in our opinion.

Year-to-date, the Utility Index has outperformed the Energy Index by 253 basis points (see table).

The Utility Index outperformed the Energy Index in three other time frames in today’s table (10-Year, 15-Year, and 20-Year). Year-to-date through 6/21/24, the Utilities Index is the third-best performing sector in the S&P 500 Index, behind the Information Technology and Communication Services Indices, with total returns of 28.79% and 25.10%, respectively. For comparison, with a total return of -7.08%, the Utilities Index was the worst performing sector in the S&P 500 Index in 2023. We think that surging forecasts for electricity demand may explain this dramatic turnaround. In a recent report, Citi Research estimated that the peak utility power demanded by the world’s data centers will rise at a 15% compound annual growth rate from nearly 50 gigawatts in 2023 to over 130 gigawatts in 2030. Processing for AI applications is expected to account for more than 50% of total data center power usage in 2030.

Takeaway: With total returns of -7.08% and -1.42%, respectively, the Utilities and Energy Indices were the only S&P 500 Index sectors to post negative total returns in 2023 (not in table). So far in 2024, they are enjoying a significant turnaround. As of 6/21/24, earnings for the Utilities Index are forecast to increase by 13.41% in 2024, well above the 9.58% earnings growth rate of the broader S&P 500 Index. In our view, the earnings growth expectations of the Utilities Index can be largely attributed to burgeoning demand for electricity to power AI-centric data centers. In addition, most households will keep using their lights, air conditioning, stoves, and furnaces even if budgets are stretched and commodity prices fluctuate. Energy stocks, on the other hand, are forecast to see earnings decline by 5.4% in 2024. One reason for this could be slowing economic activity. In the U.S., real GDP increased at a pace of 1.3% in Q1’24, down from 3.4% in Q4’23. Lower economic activity means fewer deliveries, trips to the store, and travel, which can have a negative effect on the earnings of energy companies.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P 500 Energy Index is a capitalization-weighted index comprised of 21 companies spanning five subsectors in the energy sector. The S&P 500 Utilities Index is a capitalization-weighted index comprised of 29 companies spanning five subsectors in the utilities sector. 

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View from the Observation Deck
 
Investors tend to utilize money market funds during times of uncertainty such as the financial crisis in 2008 – 2009, the COVID-19 pandemic of 2020, and the banking crisis in March 2023. Recently, investors have continued to pile cash into money market accounts despite compelling returns in the U.S. equity markets (see chart). A note about the chart: we use the federal funds target rate (upper bound) as a proxy for short-term interest rates, such as those offered by taxable money market funds and other savings vehicles. In our opinion, this proxy may offer insight into the potential effect of short-term rates on investor behavior.

• After growing to an all-time high of $5.98 trillion on 1/10/24 (the last time we posted on this topic), total net assets in U.S. money market accounts increased to a record $6.12 trillion in June 2024.

As of 6/12/24, total net money market fund assets stood at $6.12 trillion, approximately $2.20 trillion, and $1.33 trillion higher than their levels on 1/14/09 (peak during financial crisis) and 5/20/20 (peak during COVID-19 pandemic), respectively. 

• From March 2020 to March 2022, the Federal Reserve ("Fed") kept the federal funds target rate (upper bound) at 0.25%. Since then, the Fed initiated eleven increases to the target rate, raising it from 0.25% to 5.50% where it stands today. 
• Inflation, as measured by the 12-month change in the Consumer Price Index, stood at 3.3% on 5/31/24, down only slightly from 3.4% at the end of 2023, but well below its most recent high of 9.1% set in June 2022.
  
• As of 6/17/24, the federal funds rate futures market was pricing in less than two rate cuts for a total of 45 basis points (bps) in 2024. For comparison, the same market projected more than six rate cuts totaling 158 bps on 12/29/23.

We think that these three factors could account for the recent (post-COVID) surge in U.S. money market account assets shown in the chart. While inflation is still an issue, it has eased from its most recent high. This has led to positive real yields (yield minus inflation) across numerous fixed income classes. We wrote on this topic in August 2023 (click here to read “Finally, a Real Yield”). Moreover, as the likelihood of a late-year rate cut diminishes, so too does the probability that the yield offered by fixed income instruments will suffer a significant downturn in the near-term. The relatively stable net cash flows and high liquidity offered by money market funds have clearly been motivating factors to many investors, in our opinion.

Takeaway: Total net U.S. money market fund assets stood at a record $6.12 trillion on 6/12/24, representing an increase of $1.33 trillion since their peak during the COVID-19 pandemic. In our view, positive real yields brought on by higher interest rates and easing inflation, combined with the decreasing likelihood of multiple rate cuts in 2024, may be driving money market assets higher. We think it is healthy to see real yields trending upward, but investors should be aware that allocations to less-risky assets may come at a cost to positive returns. While money market funds may offer principal stability and income, their total return has lagged the S&P 500 Index, which surged by 26.26% on a total return basis in 2023, and 15.53% year-to-date through 6/17/24. Even accounting for the myriad of short-term risks that currently exist, we believe that an allocation to equities will continue to generate a higher return on capital than cash over time.

This chart is for illustrative purposes only and not indicative of any actual investment. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.  

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View from the Observation Deck  
Tracking the direction of worldwide semiconductor sales can provide investors with additional insight into the potential demand for tech-oriented products and the overall climate for technology stocks, in our opinion. As evidenced by recent developments in artificial intelligence (AI) and robotics, as well as the vast market for smartphones, tablets, and wearables, we continue to find creative and innovative ways to integrate semiconductors into our everyday lives.

Semiconductor sales appear to lag fluctuations in the valuations of technology stocks.

Historically, it has been atypical to observe a persistent divergence between global semiconductor sales and the performance of the S&P 500 Technology Index. That has not been the case so far in 2024. As revealed in the chart, the S&P 500 Technology Index closed at an all-time high near the end of March 2024. Semiconductor sales, however, have yet to recapture their record highs which were set in 2022.

Worldwide sales of semiconductors totaled $137.7 billion in Q1’24, an increase of 15.2% from Q1’23, but down 5.7% from Q4’23.

Amidst unprecedented demand, the Semiconductor Industry Association reported that worldwide semiconductor sales surged by 26.2% to settle at a record $555.9 billion in 2021. In 2022, sales rose to another record of $574.1 billion, but had begun to stagnate in the second half of the year. In 2023, worldwide sales of semiconductors declined by 8.2% year-over-year to $526.8 billion. 

The technology sector continues to be a top performing sector compared to its peers. 

Propelled forward by promising developments in AI and an easing in the global chip shortage, the S&P 500 Information Technology Index rose by 57.84% in 2023. In our view, these factors remain relevant today, and continue to entice investors to the sector. Year-to-date through 5/29/24, the S&P 500 Information Technology Index posted a total return of 20.25%, second only to the S&P 500 Communication Services Index which rose by 21.48% on a total return basis over the same time frame.

Takeaway: It is nearly impossible to discuss semiconductors and technology stocks without mentioning developments in AI, and rightly so. One forecast suggests the global AI market could grow to nearly $600 billion by 2026 and $1.8 trillion by 2030, according to Ryan Issakainen, ETF Strategist at First Trust Portfolios L.P. These growth projections, coupled with expectations that the Fed could cut interest rates in the first half of 2024, led to an unprecedented surge in the S&P 500 Information Technology Index, which rose by 57.84% on a total return basis in 2023. That growth has continued in 2024. While the valuations of technology companies are spiking, global semiconductor sales remain below their all-time high set in 2022. With the chip shortage behind us, and increased demand due to the compute power required for AI, global semiconductor sales are expected to recover this year. In February 2024 (most recent data), the Semiconductor Industry Association forecast that the global semiconductor market will grow by 13.1% in 2024.

This chart is for illustrative purposes only and not indicative of any actual investment. There can be no assurance that any of the projections cited will occur. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Information Technology Index is capitalization-weighted and comprised of S&P 500 constituents representing the technology sector. The S&P 500 Communication Services Index is capitalization-weighted and comprised of S&P 500 constituents representing the communication services sector.

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The blog will resume on Tuesday, June 18th.

View from the Observation Deck  

We update this post on an ongoing basis to provide investors with insight into the earnings beat rate for the companies that comprise the S&P 500 Index (“Index”). As many investors may know, equity analysts adjust their corporate earnings estimates higher or lower on an ongoing basis. While these estimates may provide insight into the expected financial performance of a given company, they are not guarantees. From Q1’20 through Q1'24 (the 17 quarters in today’s chart), the average earnings beat rate for the companies that comprise the Index was 77.4%.

As indicated in today’s chart, the percentage of companies in the Index that reported higher than expected earnings in Q1’24 stood 1.3 percentage points below the 4-year average of 77.4%.

The Index’s earnings beat rate outpaced the average in just seven of the 17 quarters represented. More recently, the beat rate missed the average in seven of the past eight consecutive quarters. Keep in mind that the Q1’24 data in the chart reflects earnings results for 460 of the 503 companies that comprise the Index and could change slightly over the coming weeks. 

As of 5/14/24, the sectors with the highest earnings beat rates and their percentages were as follows: Information Technology (86.3%); Consumer Staples (86.2%); and Health Care (85.3%), according to S&P Dow Jones Indices. Energy had the lowest beat rate at 56.5%. The Real Estate sector had the highest earnings miss rate (29.0% during the quarter). 

Despite lower-than-average earnings beat rates, the Index surged by 13.84% on an average annual total return basis from 12/31/19 to 5/21/24.

We see several reasons for this. First (and perhaps most obvious) is that earnings beats are still occurring for the overwhelming majority of companies in the Index. Another is that the Index is enjoying an above average earnings surprise percentage (the difference between actual earnings and estimated earnings). FactSet reported that on aggregate, the actual earnings for the companies that comprise the Index stood 7.5% above their estimates in the first quarter of 2024. For comparison, the metric averaged 6.7% over the past 10-years.

Takeaway: While earnings beats are generally viewed as positive for the overall market, they represent just one piece of an intricate puzzle. As today’s chart reveals, the earnings beat rate for the companies that comprise the S&P 500 Index has been below the average in most of the quarters we presented. Despite this fact, the S&P 500 Index closed at a record 5,321.41 on 5/21/24, representing an increase of 48.77% on a price only basis from its most recent low of 3,577.03 (10/12/22). As we have mentioned previously, we view revenue growth as foundational to growth in earnings. While not in today’s chart, the blended revenue growth rate for the Index stood at 4.2% on 5/17/24, according to FactSet. Barring a significant change in revenue growth rates over the coming weeks, this would mark the fourteenth consecutive quarter of revenue growth for the S&P 500 Index. Notably, the overall blended earnings growth (combines actual results with estimates for companies yet to report) for the companies in the S&P 500 Index stood at 5.7% on a year-over-year (y-o-y) basis in Q1’24. If that figure holds, it will represent the highest quarterly earnings growth rate for the Index since Q2’22.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 is a capitalization-weighted index comprised of 500 companies used to measure large-cap U.S. stock market performance. 

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The blog will resume on Thursday, May 30th.

View from the Observation Deck  

As we near the end of the Q1’24 earnings season, we thought it would be timely to provide an update regarding estimated 2024 and 2025 earnings and revenue growth rates for the companies that comprise the S&P 500 Index (“Index”). On May 17, 2024, the Index closed at 5,303.27, representing an increase of 11.18% on a price-only basis from when it stood at 4,769.83 on December 29, 2023, according to data from Bloomberg. For comparison, from 1928-2023 (96 years) the Index posted an average annual total return of 9.56%. In our post on this topic from October 2023 (click here), we wrote that increased revenues could boost earnings and provide the catalyst for higher equity valuations going forward. We believe that the Index’s notable surge over the past months is reflective, in part, of that scenario playing out.

Current estimates reveal favorable earnings growth expectations over the next several years. 

As today’s table shows, the earnings for the companies that comprise the S&P 500 Index are expected to increase by a combined 9.4% and 13.8%, respectively, on a year-over-year (y-o-y) basis in 2024 and 2025. These figures are marginally lower than when they stood at 9.5% and 13.9%, respectively, the last time we posted on this topic (click here). Keep in mind that estimates for 2024 reflect favorable comparisons to 2023’s earnings which declined by 0.9% in 2023 (not in table). In 2024, earnings are estimated to decline in just two of the eleven sectors that comprise the Index (Energy and Materials). While negative earnings are never favorable, the Energy and Materials sectors’ 2024 earnings estimates show substantial improvement from our last post, when estimates stood at -6.2% and -4.0% respectively, in 2024.

Revenue growth rate estimates for 2024 and 2025 are also favorable.

As of May 17, 2024, the estimated revenue growth rate for companies in the Index stood at 4.5% and 5.7%, respectively, in 2024 and 2025. These figures are also marginally lower than when they stood at 4.7% and 5.9%, respectively, in 2024 and 2025, the last time we posted on this topic. Nine of the eleven sectors that comprise the S&P 500 Index reflect positive y-o-y revenue growth rate estimates for 2024 with four of them estimated to surpass 5.0%.

Takeaway: As many investors may be aware, equity markets are forward-looking discounting mechanisms. Practically speaking, the price of an efficient market should reflect the sum-effect of present and future (expected) events. We think the recent surge in the S&P 500 Index, which rose by 11.18% (price-only) year-to-date through May 17, 2024, can be explained, in part, by the expected earnings and revenue growth rates revealed in today’s table. Additionally, early-year expectations of multiple cuts to the federal funds rate also played a role in the Index’s growth, in our opinion. That said, information flows quickly, and estimates are subject to constant revision. Time will ultimately reveal the accuracy of these forecasts, but we maintain that higher revenues in the coming years could be the best catalyst for growing earnings, and in turn, higher equity valuations.

This chart is for illustrative purposes only and not indicative of any actual investment. There can be no assurance that any of the projections cited will occur. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The respective S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector. 

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View from the Observation Deck

As many investors likely know, given their non-cyclical nature, defensive sectors may offer better performance than their counterparts during periods of heightened volatility. For today’s post, we set out to determine if that outperformance also exists during periods of high inflation. To construct the table above, we started in 1990 and selected calendar years where inflation, as measured by the Consumer Price Index (CPI), increased by 3.0% or more on a trailing 12-month basis. We chose 3.0% as our baseline because the rate of change in the CPI averaged 3.0% from 1926-2023, according to data from the Bureau of Labor Statistics. We then selected three defensive sectors (Health Care, Consumer Staples, and Utilities) and compared their total returns to those of the S&P 500 Index over those periods.

• Of the twelve time frames in the table where inflation increased by 3.0% or more on a trailing 12-month basis, there were only two (2021 and 2023) where the S&P 500 Index outperformed each of the Health Care, Consumer Staples, and Utilities sectors.
  
  
• The CPI remains elevated in 2024, and the S&P 500 Utilities Index has been the top performer, outpacing the broader S&P 500 Index by 3.25 percentage points year-to-date through 5/14/24.

One reason for the Utilities sector’s outperformance so far in 2024 is the rise in global usage of Artificial Intelligence (AI). The International Energy Agency reported that the global electricity consumed by data centers, which typically house the servers that host AI graphics processing units, is forecast to surge from an estimated 460 terra-watt hours in 2022 to more than 1,000 terra-watt hours in 2026. For comparison, this demand is roughly equivalent to the electricity consumption of Japan.

• From 12/29/89 – 5/14/24 (period captured in the table above), the average annualized total returns posted by the four equity indices presented were as follows (best to worst): 11.60% (S&P 500 Health Care); 10.51% (S&P 500 Consumer Staples); 10.39% (S&P 500); and 8.19% (S&P 500 Utilities); according to data from Bloomberg.

Takeaway: Today’s table reveals that defensive sectors often outperform the broader S&P 500 Index during periods of higher inflation. The S&P 500 Index underperformed at least one defensive sector in roughly 83% of the calendar years (including year-to-date) where inflation increased at a rate of 3.0% or more on a trailing 12-month basis since 1990. That said, outliers do exist, as proven by the S&P 500 Index’s performance in both 2021 and 2023. Additionally, as there is no way to predict which defensive sector will offer the best performance when inflation is elevated, investors should take care to remain appropriately diversified. From our perspective, if the CPI remains at 3.0% or above, we expect investor interest in defensive sectors will continue to grow; perhaps even more so if the economic climate begins to deteriorate. 

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The respective S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector.  

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View from the Observation Deck

Total assets invested in covered call strategies have been growing rapidly over the past several years. Data from Morningstar Direct revealed that net assets in the “derivative income” group totaled $70.7 billion in May 2024, up from $44.5 billion over the same period the year before, according to Reuters.

Covered call strategies tend to be most beneficial when the stock market posts negative returns, or when returns range from 0%-10%.

The S&P 500 Index posted negative total returns just three times in the table above. The CBOE BuyWrite Index outperformed the S&P 500 Index in two of those three years (missing the third year by 0.39 percentage points in 2018). For comparison, there are four years in the table where the S&P 500 Index posted returns between 0% and 10%. During those time periods, the CBOE BuyWrite Index outperformed the S&P 500 Index in three of the four years (missing the fourth year by 0.66 percentage points in 2005).

Covered call options can generate an attractive income stream and serve as a hedge against negative price movement, but they may limit the potential for capital appreciation.

There were 12 years in today’s table (not including 2024) where the S&P 500 Index notched total returns of 10% or more. The CBOE BuyWrite Index underperformed the S&P 500 Index in every one of them. Perhaps unsurprisingly, a similar story has played out so far in 2024. The S&P 500 Index’s total return stood at 10.03% on a year-to-date basis through 5/10. For comparison, the CBOE BuyWrite Index rose by 5.80% on a total return basis over the same period.

Takeaway: Covered call strategies may serve as a unique alternative to the S&P 500 Index. While the income they provide has generally led to outperformance during negative or moderately positive periods, returns can be capped during periods where the market is performing exceedingly well. As a recent example, the S&P 500 Index surged by 26.26% in 2023, outperforming the CBOE BuyWrite Index by 14.44 percentage points. Year-to-date through 5/10/24, the total return of S&P 500 Index has nearly doubled that of the CBOE BuyWrite Index. Forecasts suggest this lead may not hold. On April 15, 2024, a Bloomberg survey of 21 equity strategists revealed that their average 2024 year-end price target for the S&P 500 Index was 5,065. On 5/10/24, the S&P 500 Index closed at 5,222.68, 3.11% above those forecasts.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The CBOE S&P 500 BuyWrite Index (BXM) is designed to track a hypothetical buy-write strategy on the S&P 500. It is a passive total return index based on (1) buying an S&P 500 stock index portfolio, and (2) "writing" (or selling) the near-term S&P 500 Index (SPXSM) "covered" call option.
The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.  

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View from the Observation Deck

The Energy Information Administration (EIA) reported that U.S. petroleum consumption averaged nearly 20.28 million barrels per day in 2022, an increase of almost 12% from average daily consumption in 2020, according to its own release. While many pundits predict that petroleum usage will decline over the long-term, oil was the most-consumed energy source in the U.S. on an annual basis in 2022. Today’s post contrasts the price of West Texas Intermediate (WTI) crude oil to the number of rotary drilling rigs (a proxy for supply) deployed in the U.S. on a weekly basis, over a two-year time frame.

• The price of WTI crude oil stood at $78.11 per barrel at the close of trading on 5/3/24 (end of chart), down 25.39% from its closing price of $104.69 on 4/29/22 (start of chart), according to data from Bloomberg.
  
  
• The average daily price of crude oil was $83.08 per barrel during the period captured in the chart. The highest and lowest closing prices were $122.11 and $66.74 per barrel on 6/8/22 and 3/17/23, respectively.
  
  
• For comparative purposes, the S&P 500 Energy and S&P 500 Indices posted average annual total returns of 15.17% and 13.13%, respectively over the same time frame. The top-performing energy subsector, of which there are five, was the S&P 500 Oil & Gas Refining & Marketing subsector, with an average annual total return of 34.76%.
  
  
• The number of active U.S. oil rigs declined from 552 on 4/29/22 to 499 on 5/3/24, according to data from Baker Hughes. The most recent high for the metric was 627 on 12/2/22.

Takeaway: On 5/3/24, the price of a barrel of WTI crude oil stood at $78.11 per barrel, 36.86% below its most recent high of $123.70 which occurred on 3/8/22, just a few weeks after Russia’s invasion of Ukraine. Remarkably, crude oil prices declined over this period despite sanctions against Russian oil and Hamas’s invasion of Israel. In our view, surging U.S. crude output has likely contributed to this phenomenon. The EIA reported that U.S. crude oil production and crude oil exports reached record highs of 12.9 and 4.1 million barrels per day, respectively, in 2023. The export figure is notable. Prior to 2020, the U.S. had been a net importer of crude oil going back as far as 1949. The rise in the relative value of the U.S. dollar may also be a contributing factor to the decline in crude oil prices over the past few years. From 3/8/22 through 5/3/24, the U.S. dollar rose by 6.02% against a basket of major foreign currencies, as measured by the U.S. Dollar Index (DXY).

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P 500 Energy Index is a capitalization-weighted index comprised of 500 stocks representing the energy sector. The S&P 500 Energy Index is comprised of five subsectors.

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View from the Observation Deck

Dividend payments have been a key characteristic of most of the companies that comprise the S&P 500 Index (“Index”) for decades. As of 4/30/24, 404 of the 503 companies that comprise the Index paid a dividend. That figure is little changed from 1998, when 418 companies in the Index paid dividend distributions to shareholders. For today’s discussion, we set out to explain the fundamental relationship between dividends and earnings, and to determine if the recent record-high earnings in the Index have translated into higher yields.

The companies that comprise the Index distributed a record $588.2 billion in dividends in 2023, up 4.2% from $564.6 billion in 2022. Despite record distributions, the dividend yield of the S&P 500 Index has been trending downward (see chart). 

Companies will often increase their dividend distributions just enough to keep yields from falling as valuations increase. Over the 10-year period between 12/31/09 and 12/31/19, the Index posted an average annual total return of 13.54%. The Index’s yield fluctuated between 1.76% and 2.41% (2.01% on average) over the time frame. For comparison, the yield on the Index averaged 1.95% over the full period captured in today’s chart.

As of 5/3/24, the yield on the Index stood at just 1.39%.

As of 5/3/24, full-year earnings estimates for the Index were forecast to reach record levels of $244.67 and $277.47 in 2024 and 2025, respectively.

Given that dividends are paid from profits, a company’s ability to grow its earnings plays a crucial role in assessing its capacity to maintain (or grow) its dividend payout. From our perspective, the consistent, long-term pattern of earnings growth revealed in today’s chart, combined with the recent decline in the Index’s yield, could be a signal that the environment is ripe for dividend growth.

The S&P 500 Index’s dividend payout ratio is currently well-below average.

As many investors are likely aware, the dividend payout ratio measures the percentage of earnings that are paid to shareholders in the form of dividends. The Index’s dividend payout ratio stood at just 35.65% on 4/30/24. For context, the Index’s dividend payout ratio averaged 41.90% over the period captured in today’s chart.

Takeaway: Dividends have played an indispensable role in equity valuations for many decades. As noted above, the combination of low current yields, record-high earnings, and a below-average dividend payout ratio may be an indication that conditions are conducive to near-term dividend growth for the Index. That said, companies will be watching closely for evidence of an economic slowdown. Should weakness manifest, we expect they will likely hoard their cash rather than distribute it back to shareholders.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance.

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