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Since the S&P 500 bottomed on March 23rd, the stock market has taken off while economic fundamentals have worsened. As of May 15th, the S&P 500 was up 28.4% from its trough while unemployment stands at 14.7%, April retail sales fell 16.4%, and industrial activity dropped by 15.5%. The S&P 500 has recouped more than 50% of its losses and sits just 15% below its all-time high.
Digging deeper into the underlying performance of the market, it becomes evident that not all of Wall Street has participated in the rebound. Market breadth, which compares the number of stocks that have gained relative to the ones that have declined, has been especially narrow. As a result, the market can be separated into a relatively few “Haves” and many “Have Nots.” The “Haves” are the largest five companies in the S&P 500: Facebook, Apple, Amazon, Microsoft, and Google (FAAMG) and the “Have Nots” are the other 495 companies in the index. Year-to-date as of May 15, 2020, the top five stocks returned 11.8% and outperformed the bottom 495 stocks before, during, and after the market decline. The bottom 495 stocks returned -15.3% year-to-date, representing a 27% performance gap. This leads us to two questions: Is the market rebound warranted? And, will the performance dispersion between the “Haves” and “Have Nots” fade anytime soon?
Equity markets are a forward-looking indicator of economic and corporate conditions. Yes, current fundamentals are not good, but analysts expect economic growth and corporate earnings to rebound later this year and into 2021, along with the development and release of a vaccine that can eradicate further outbreaks of COVID-19. In addition, stock markets often trough before the release of the worst economic data and before recessions end. Therefore, the forward-looking nature of the market seems to justify the market rebound to date.
Regarding the “Haves” and “Have Nots”, the market seems to believe the winners are large Technology companies and the losers are everyone else and/or any company exposed to COVID-19. There is fundamental support to favoring FAAMG. For example, Microsoft reported a 15% increase in sales, Google surpassed revenue expectations despite the potential for a decrease in advertising sales, and Apple has one of the most cash-rich balance sheets in the country. So, it is plausible that these stocks can continue to outperform. The longest period of similarly narrow breadth occurred in the two-plus years leading up to the bursting of the Tech Bubble. Consequently, periods of narrow breadth are often a harbinger of market declines and have “signaled below-average 1-, 3-, and 6-month S&P 500 returns as well as larger-than-average prospective drawdowns.”¹ We know that eventually the other 495 stocks in the S&P 500 will have more attractive fundamentals and will command higher prices. At that point, the return dispersion between the “Haves” and “Have Nots” will normalize, we just do not know when, though it will likely coincide with more positive economic data and greater containment of the coronavirus pandemic.
¹ Goldman Sachs Portfolio Strategy Research, May 1, 2020. “U.S. Weekly Kickstart.”
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