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Market Recap: Live by the Sword, Die by the Sword Thumbnail

Market Recap: Live by the Sword, Die by the Sword

Just as everyone seemed to be enjoying continued rallies in the stock markets, we got pummeled on Thursday and Friday of last week, which extended into today.  The stock market’s 5-week winning streak came to an abrupt end, as the Dow (-1.7%), NASDAQ (-3.3%), and S&P 500 (-2.3%) were all down for the week.  Just on Thursday and Friday, the Dow was down 3.3%, the NASDAQ down 6.2%, and S&P 500 down 4.3%.  These indices were led by the tech giants Facebook, Apple, Amazon, Microsoft, and Google (the five so-called FAAMG stocks) that were all down 6.5% - 8% in the final two days of last week.  Taxable bonds were up about 0.3% last week, while muni bonds were down slightly, about 0% - 0.2%.  Investors should also be receiving their August statements in the mail, and they will be pleased with what they see.  Those investors with diversified portfolios will likely enjoy an increase of approximately 1.5% (conservative) to about 5% (more aggressive), as stocks rallied during the month of August.  If you wish to press on, I will get into more detail about the markets.

 

As noted above, the markets fell sharply in the last 3 trading days, but were led by those 5 FAAMG stocks.  For those that have been following my weekly recaps for the past few months, you’ll know that those 5 stocks tend to drive the indices that we all see and hear on the news each day.  After all, they make up nearly ¼ of the S&P 500 and ½ of the NASDAQ, but a smaller percentage of the Dow.  I read an article over the weekend by Howard Marks of Oaktree Capital Management, LLP, and he laid out some pretty fascinating information that is consistent with what I’ve been portraying for a while now, but also pointed out some other facts that supported their ascent.

 

At the end of July, the S&P 500 was roughly even for the year, but those 5 stocks were up about 35%.  Meanwhile, the median value of the remaining 495 stocks was down 11%.  In a statement I made in August, the S&P 500 was up 3%, and the average of the remaining 495 stocks was down 5%.  Note that the average and median are different statistical measures, but in this case, provide a similar conclusion.  Simply put, the S&P 500 index is driven by a small handful of stocks.  For those investors holding a high concentration of those stocks, they enjoyed some pretty substantive gains, even in the face of the pandemic.  Meanwhile, the more diverse investors exhibited gains, but to a lesser extent.

 

So why has the stock market performed so well under these conditions, especially the tech giants?

 

  1. The reduction in interest rates to near zero has increased the value of investment assets and spurred a local bidding war that has raised their prices.  Further, many investors have underestimated the impact of low rates on valuations.
  2. The stock market earnings yield is the inverse of its PE.  So if the PE is 20, then its earnings yield is 100 / 20 = 5%.  Given the Treasury rate below 1%, some argue that the stock market PE (and its corresponding values) could double from its current value.
  3. The Fed has flooded the economy and the markets with liquidity and other forms of support for individuals, companies, and institutions.
  4. The Fed and the Treasury seem willing to provide support and stimulus well into the future.
  5. Tech giants grow faster than larger companies of the past, and can warrant a higher PE and valuation.
  6. Tech giants have technological advantages and network effects that give them much greater protection against competition.
  7. Tech giants’ primary capital is intellectual property, so they can grow rapidly at relatively low marginal costs.

 

Of course, the herd mentality kicked in and many investors didn’t want to miss the train before it left the station.  This helped propel stocks to grow at an unusual growth rate, possibly ahead of themselves.  I heard an unconfirmed story today that a bank had to unload billions of dollars of stock investments, causing the markets to drop precipitously.  An event like this can subsequently cause the stock values to unravel due to program trading.  Program trading occurs when investors put in “stop orders” that cause their stocks to be sold if they drop to a certain price, which could trigger the domino effect if enough is being sold.  So, for those investors who were chasing returns and made very good returns with these 5 stocks, they may be the same ones who watched them tumble over the last 3 trading days.  There are many metaphors that can be used here.  “Play with fire, you get burned” or “Live by the sword, die by the sword”.

 

On a separate note, I just conducted an evaluation of three of our portfolio models (conservative 30, Moderate 60, and Aggressive 80, which represent the approximate stock % in the portfolios).  I compared them to the three major indices, both from a performance perspective, as well as the amount of FAAMG stocks they contain.  These data are shown in the table below.

 

As demonstrated by the table, the indices containing the highest percentage of the FAAMG stocks clearly performed better YTD.  However, it also demonstrates that maintaining a diversified portfolio of stocks AND bonds oftentimes can create comparable gains, but at a significantly lower level of risk.

 

As of 9/4/20

YTD

% FAAMG in Portfolio

Dow

0.3%

15%

NASDAQ

26.9%

46%

S&P 500

7.5%

22%

30% Model

5.1%

< 1%

60% Model

6.2%

3%

80% Model

7.2%

6%

 

Thus, while these portfolios haven’t gained close to the 35% of the FAAMG stocks, they haven’t tumbled nearly as much over the past several days.  The moral of the story is don’t panic if you see the markets go down precipitously, because that may not be reflective of the investments that you are in. 

 

Have a great day!




NEITHER VOYA FINANCIAL ADVISORS NOR ITS REPRESENTATIVES OFFER TAX OR LEGAL ADVICE.  PLEASE CONSULT WITH YOUR TAX AND LEGAL ADVISORS REGARDING YOUR INDIVIDUAL SITUATION.   INVESTMENT ADVISOR REPRESENTATIVE AND REGISTERED REPRESENTATIVE OF, AND SECURITIES AND INVESTMENT ADVISORY SERVICES OFFERED THROUGH VOYA FINANCIAL ADVISORS, INC. (MEMBER SIPC.) MENNINGER & ASSOCIATES, INC. IS NOT A SUBSIDIARY OF NOR CONTROLLED BY VOYA FINANCIAL ADVISORS, INC.  CN1325952_0922












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