Monthly Brief August 2020 – The S&P 5?
August 2020 closed out with another month of gains for US equity indexes, marking five consecutive positive months for the S&P 500 Index following the February/March sell-off. 2020 has provided several eye-catching statistics, but underneath the headlines, not all stocks have participated in the rebound in the same manner.
After the initial recovery from the March bottom, the rate of advance has varied considerably with the Technology and Consumer Discretionary sectors having significantly outpaced the rest of the market, led by a narrow list of companies referred to by monikers such as “COVID Winners”.
Such narrow leadership presupposes that the economy remains weak and/or prospects for the broader market are uncertain at best. How can a handful of companies see such lofty gains while the general economic, social and political climates suggest caution? If the economic climate is tenuous, shouldn’t there be more concern regarding risk-taking? Or, if the economic picture is improving, wouldn’t it be expected that capital would flow towards economically sensitive companies that are priced at relatively inexpensive levels?
The missing piece in this unusual scenario of the past few months is the abundance of available capital (i.e. “liquidity” provided by the many unprecedented global stimulus measures) that, unable to find attractive opportunities for investment in the real economy, finds its way into the capital markets. With only a narrow number of candidates currently deemed “attractive”, this liquidity flows disproportionally to these stocks and the law of supply and demand (significant capital moving to the same narrow handful of stocks) drives their prices higher.
Where might this go from here? It would seem that there are three potential paths. The obvious one is “more of the same” with capital continuing to flow to the anointed “COVID winners” circle. But, under the hood, it looks as though this trend may be getting long in the tooth, suggesting a change in the regime. The optimist might see genuine reasons to believe in better economic conditions ahead and, as the economy’s health improves, capital rotates to less expensive, economically sensitive opportunities in the broader market. Or the cynic may say that this has all been the result of too much stimulus without real opportunities for investment due to poor prospects for real economic improvement. In this case, the excess capital that went into the COVID winners could reverse course and lead a market pullback led by the most expensive areas of the market, yet more modest for the broader market. (The market cap-weights indexes may obscure this dichotomy just as they have during the advance in prior months).
For investors, handicapping which of these scenarios may play out is clearly difficult and we haven’t yet talked about the effect of the upcoming election…
CHART OF INTEREST – The S&P 5 ???
Intuitively, most investors would find a market advance supported by broad participation to be healthier than periods when leadership is limited to only a handful of stocks. And 2020 has certainly set a high bar for how extreme a narrow market can be.
The impact of the narrow participation during 2020 has been remarkable. For the year, through August 31, the S&P 500 Index is up 9.7%. Of the roughly 500 stocks in the index, the contribution of the five best performers has added 10.2% to the index. Yes, that does mean that the cumulative contribution of the remaining 500+ equity issues in the index has been negative year-to-date through August 31 (it’s not unusual for there to be modestly more than 500 issues in the index). Of these five stocks, Apple, Amazon and Microsoft alone have accounted for 89% of the S&P 500’s year-to-date gains. This is not exactly evidence of broad participation.
But this does not necessarily mean this year’s rebound is groundless. Rather, one might look at this as an opportunity following the gains of the few. Should a catalyst for greater confidence in improved broadening of global growth begin to show itself, there remain many opportunities with the potential for further gains. This strange time we live in has brought us to a place with two strong influences converging over the coming months: the presidential election and potential advancement in treatments for the COVID virus pandemic.
James Ferrin, CFA
Chief Investment Officer
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