Is the stock market crazy?
Many investors are asking that question after the recent rally. The S&P 500 is down approximately -11% year-to-date, having rallied from being down -31% year-to-date as of the low on March 23rd. Over the past twelve months, the S&P 500 is now up +0.4%. The NASDAQ is up +0.5% year-to-date, and believe it or not, it's up a healthy +15% from year-ago levels.
Given the damage COVID has wreaked on our economy, it is tempting to interpret this recent strength as crazy. Is it? Could it be a bear-market rally? Time will tell. We have no "edge" on forecasting near-term market moves.
Here are four reasons that the market's resilience might not be irrational:
1. There’s less uncertainty.
Markets hate uncertainty. There’s lots of it still, for sure. But there is a narrower range of possible futures.
2. Long-term outlook remains good.
The stock market’s value is based upon what investors expect companies to earn looking forward. The lion’s share of that value is derived from the earnings in the out-years. Only a small portion of the valuation is derived from earnings over the next year or two. Whatever the risks of COVID in the coming year (or even years), most investors believe the global economy will adapt and ultimately return to pre-COVID levels in the longer-term. (Granted, the mix within the economy will surely shift – for example: less brick & mortar retail, more testing and healthcare services.)
3. The Fed’s new mandate.
Apparently, the Fed has expanded its mandate beyond full employment and price stability. Now the Fed appears to be in the business of ensuring market price stability. Investors have observed its unprecedented support over the past several weeks and drawn a rational conclusion: The risk of owning “risk assets” such as stocks and high yield bonds has gone down.* Just this week the Fed announced its intention to buy bond ETFs to provide further support.
And perhaps most importantly . . . (drum-roll, please)
4. It’s actually an illusion.
Looking through the lens of traditional benchmarks, the stock market looks to have largely recovered. However, the most prominent benchmarks like the S&P 500 are weighted according to market size. This means that the largest companies make up the lion’s share of their returns. The five largest companies in the S&P 500 are Microsoft, Apple, Amazon, Google and Facebook. Together they comprise ~21% of that index. COVID has either not affected or benefited these companies. The stocks of all five are up year-to-date. For the NASDAQ, this concentration is even more extreme: these same five companies make up ~38% of that index.
A small handful of companies are thus driving the surprisingly resilient stock market returns of the major indices. A look at all the other companies shows a far different story. The S&P 500 Equal-Weighted index (which balances all 500 stocks equally rather than by size) is down -21% year-to-date, almost twice as much as the traditional S&P 500. The Russell 2000, which is a broad index of small stocks, is down -25% year-to-date. Even worse is the performance of stocks that are both small and cheap: the Russell 2000 Value index is down -35% for the year.
What to make of all this?
Prices for most stocks are much cheaper than they were a few months ago. That does not make them necessarily good investments in a post-COVID world. It does, however, make for a more attractive hunting ground.
Last week Steve Korn and I discussed our evolving views in light of this new environment, which you can watch or listen to HERE.
We welcome any additive or contrary thoughts from our clients and friends (our most valuable resource).
Frank Byrd, CFA, CFP®
Fielder is an independent, fee-only adviser that provides asset management and family office services.
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