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August 17, 2020

What Gives?

Author: Marty Moore, CFP®

The U.S. economy shrunk by 9.5% in the second quarter, the result of the self-imposed shutdown of our economy.  The stock market was up 20.5% during this time and is now positive for the year, up 2.4%.  (S&P 500, July 31, 2020; BTN Research)
 
How could this be?
 
The short answer might be:

  1. The stock market is always looking ahead.  It doesn’t necessarily reflect what’s going on today.  Investors overall (“the market”) expect an eventual vaccine for COVID-19 and a subsequent strong rebound in the economy.
  2. The huge government stimulus programs have kept many businesses afloat and consumer spending going while limiting an even a further decline in the economy.

There is also some interesting nuance to this question.

Much of the stock market actually does reflect the depressed economy. 

Many (most, really) industries are suffering.  As of the end of the July, department store stocks are down over 62%; airlines, down 55%; travel services, down 51%; oil and gas services and equipment, down 50%; resorts and casinos, down 45%; hotel and motel real estate investment trusts, down 42%.  Fifteen other industry sectors are down 30% or more. (reported by Barry Ritholz, “Why Markets Don’t seem to Care If The Economy Stinks”)

In fact, 35% of the stocks in the S&P 500 are down at least 20% year-to-date as of the end of July!  (BTN Research)

What gives?  How can the overall market be up? 

These industries, while they are highly visible, really do not matter that much to “the market”.  The major index, the S&P 500, is made up of the 500 largest, most prominent companies in the U.S. They are not counted equally, however, in how much they contribute to the gain/decline in the performance of the index.  A company twice as big as another will count double toward the index performance.  So, while they may be considered large, blue chip companies, the smallest 50 companies in the index contribute little to the index performance relative to the largest 50 companies.

So, as you might now expect, in order for the S&P 500 to be up for the year, the largest of the large must be doing OK.  And you would be right.  A very small percentage of companies are actually doing pretty well. 

Who are these largest of the large companies?

In short, they’re the tech stocks.  The five largest companies in the U.S. are all now technology companies.

Consider how these five stocks (white line, the big 5 tech companies) have separated themselves, not just this year, but also over the past 5 years (blue line, all 495 other companies)

Currently, the overall tech sector makes up a whopping 27.5% of the S&P 500, almost double the next sector Health Care which makes up 14.6%.

Fidelity: 8/4/2020

Bottom line: Technology companies make up the lion’s share of the stock market.  They are the most important and contribute the most to the market’s performance.  Their performance this year is outstanding; the rest of the market, not so much.

Lesson here: Be diversified.  A cautious stock investor who might be overweight the most conservative sectors such as utilities and consumer staples would still be well into the red this year.

So, should you load up on tech stocks?  Only if you’re inclined to be ultra-aggressive.  Over-concentrating in any sector is risky, especially technology at this point after the strong gains relative to the rest of the market over the past several years.

Staying broadly diversified is the recommended approach.

Speaking of one of the biggies: Google

This is fascinating.  Clicking on the link below will bring you to chart of the U.S. with a day-by-day running account of the largest Google searches over the past two years.  Notice the trends, especially this year as the pandemic came on.

https://ritholtz.com/2020/07/trending-google-searches-by-state/

Predicting what lies ahead

Uncertainty continues to rule the day.  COVID trends are getting better in some ways and in certain parts of the country; worsening, it seems, in other ways and areas around the U.S.  And while the market has recovered dramatically, we can in no way rule out more market shocks as we see how COVID trends, vaccine development, more government stimulus, school openings, and other critical factors play out.

Does anyone have any real insight on what will happen over the coming months?  Can we learn anything or rely on those in the media who are all-to-happy to give us their opinion?

Financial writer Jonathan Clements offered his amusing, tongue-in-cheek take on this in his article “Just Another Day”.

Here’s a quick excerpt:

Welcome to our new daily market report, which we’re going to run exactly once, which is probably once too many.  In market action yesterday, stock prices fluctuated – a development that shocked market observers who noted they hadn’t seen anything like that since the day before.

“Investors took a breather after last week’s rally,” continued Nodamus, who talked to precisely zero investors before cavalierly summarizing their mood.  “They’re looking for stocks that will hit the ball out of the park, but these days it seems like nothing will reliably go through the uprights,” he said, adding to his illustrious history of completely meaningless sports analogies.

https://humbledollar.com/2020/07/just-another-day/

A little levity to wrap up

Speaking of sports, they’re back on; major league baseball and professional basketball, as well as PGA golf.  Terrible golfer as I am, this short video made me laugh.  On more than one occasion this dad has pulled this prank on a golfer whose errant tee shot has ended up in his back yard.

https://www.facebook.com/thedadbreak/videos/1203286520004067/

As always, thanks for reading.

Marty

Required Disclosures:

All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
The S&P 500 Index is a capitalization‐weighted index made up of 500 widely held large‐cap U.S. stocks in the Industrials, Transportation, Utilities and Financials sectors.
The Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 blue-chip stocks that trade on the New York Stock Exchange which are selected by editors of The Wall Street Journal.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Asset allocation is an investment strategy that will not guarantee a profit or protect you from loss.
You cannot invest directly in an index. Additional risks are associated with international investing, such as currency fluctuations, political and economic stability and differences in accounting standards all of which are magnified in emerging markets.
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