Look Under The Hood

“Do you feel like we do?
Do you feel like we do?
Oh, that’s true.”
–Peter Frampton, Do you feel like we do?

Every year events occur that we have not experienced before and we say “it’s different this time”. 2020 is an especially unique year. One of the most frequent questions we receive from our clients is, “How can the market be doing so well when the economy is not?”

Let’s be clear, we are in a challenging economic environment. According to the Bureau of Labor Statistics, the US unemployment rate was at 8.4% as of 9/4/2020, which is down from an all-time high of 14.7% in April 2020. Real Gross Domestic Product (GDP), the value of the goods and services produced by the United States, fell by 31.4% during the 2^nd quarter of 2020 per the Bureau of Economic Analysis. But, the Federal Reserve Bank of Atlanta provided 3^rd quarter GDP estimate of +32.0% on 9/30/2020. Data is improving as parts of our economy are reopening, but many analyst believe it may take until 2023 to get the US economy fully back on track.

A major driver of these improving figures is the Federal Reserve Bank and Congress injecting trillions of dollars into the economy and holding interest rates at historical lows. We have not experienced this type of economic stimulus since World War II. Couple this with worker productivity increases and companies reducing expenses, many companies are remaining profitable and demonstrating growth. But not all companies are equally benefiting.

“Just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again”
–The Who, Won’t Get Fooled Again

The S&P 500 Index is comprised of approximately 500 of largest American companies listed on US stock exchanges. Year-to-date (YTD) the S&P 500 Index is +5.6% (as of 9/30/2020), so it makes sense many investors wonder how can the overall market be doing relatively well while economic figures seem to share a different story? 

Before we can compare the S&P 500 Index performance versus US economic data, we need to have a stronger understanding of the index itself. We need to take a look under the hood to see what is driving this vehicle. While the S&P 500 is comprised of ~500 of the largest listed US companies, they are not equally weighted. The index is a capitalization-weighted index which means the larger the company, the larger it’s weighting and the greater the impact on the index performance. The top 10 holding of the S&P 500 (chart below) currently represent ~28% of the index! In other words, over a quarter of the index’s performance is driven by only 2% of its holdings.

* Information from www.spglobal.com as of 9/30/2020

The S&P 500 Index is comprised of 11 sectors. Technology is the largest sector and represents over 28% of the index. YTD the S&P 500 Information Technology Index is up 28.7% (as of 9/30/2020). So if the S&P 500 Index is +5.6% YTD and its largest sector which comprises over 28% of the index is +28.7%, then it proves that technology stocks are pulling the overall performance of the index upwards. 

Another way to analyze the S&P 500 Index is to compare the growth companies in the index versus the value companies in the index. For ease of comparison, we will use the S&P 500 Index (SPX), S&P 500 Growth Index (SGX) and the S&P 500 Value Index (SVX).

The S&P 500 Growth Index (SGX) seeks to offer exposure to S&P 500 companies that display the strongest growth characteristics. The top 10 holdings are:

1. Apple
2. Microsoft
3. com
4. Facebook
5. Alphabet – Class A (Google)
6. Alphabet – Class C (Google)
7. Visa
8. NVIDIA
9. MasterCard
10. Adobe

Information from www.spglobal.com as of 9/30/2020

The S&P 500 Value Index (SVX) seeks to offer exposure to S&P 500 companies that could be undervalued relative to the broader market. The top 10 holdings are:

1. Berkshire Hathaway
2. UnitedHealth Group
3. Verizon Communications
4. Johnson & Johnson
5. Pfizer
6. AT&T
7. Walmart
8. Bank of America
9. Cisco Systems
10. JPMorgan Chase

Information from www.spglobal.com as of 9/30/2020

When comparing the top 10 holdings of SGX and SVX, there is a notable difference in type of underlying companies. SGX is heavily technology weighted and growth oriented. SVX is heavily weighted into healthcare and financials and has a stronger dividend yield. The difference in annual return between SGX and SVX has been less than 12.1% in any given calendar year for the past 10 years (table below). Through the 3^rd quarter of 2020, the difference between SGX and SVX is over 32%!

* Information from www.spglobal.com as of 9/30/2020

“Where do we go?
Where do we go now?
Where do we go?
Ooh, where do we go now?”
–Gun N’ Roses, Sweet Child O’Mine

How is the stock market doing well while the economy is not? The reality is the S&P 500 Index is performing well because technology stocks are largely responsible for driving the index upwards. Only about 40% of the stocks in the S&P 500 Index are positive YTD. The table below compares the S&P 500 Index (SPX) versus the S&P 500 Equal Weight Index (SPW), which attempts to equally weight the stocks that comprise the S&P 500 Index. Over the past 5 calendar years the difference in annual return between SPX and SPW has been less than 4%. Through the 3^rd quarter of 2020, the difference between SPX and SPW is over 10%.

* Information from www.spglobal.com as of 9/30/2020

Can technology continue to lead in a challenging economic environment? We believe so.

With people working from anywhere and everywhere, the demands on technology will continue to increase. Will the need for the cloud decline or increase? Will the US and other countries stop moving forward with their 5G networks? Will the development of blockchain technology be halted? Will people stop upgrading their phones and computers? Will we stop pushing the limits on the speed and performance of microchips? No, but it is unlikely that technology companies keep outperforming at such a strong pace. 

We also believe in reversion to the mean. Asset classes that have not performed as well; like financials, healthcare and industrials, may begin to help to close the performance gap between growth and value stocks. Yields on savings accounts, money markets, CDs and bonds have declined to very low levels which make dividend paying stocks more attractive to income seeking investors.

In every market there will always be reasons for concern. Change of all types unlocks doors to opportunities. Onward & upward!

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

The information contained in this presentation does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the author, and not necessarily those of Raymond James. Expressions of opinions are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.

Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment.

Investing involves risk and you may incur a profit or loss regardless of strategy selected. The foregoing is not a recommendation to buy or sell any individual security or any combination of securities. Be sure to contact a qualified professional regarding your particular situation before making any investment or withdrawal decision.

Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results.