U.S. equities experienced a sharp correction last month with broad market indices erasing virtually all their year-to-date returns. The October pullback was especially jarring for investors since it followed an unusually quiet third quarter and had seemingly few changes in the economy or corporate earnings to warrant such a sell-off. Unlike the volatility seen in the first quarter of 2018, the S&P 500 didn’t record a single daily move of more than ±1% in the third quarter. During October, the S&P 500 saw a total of ten daily moves greater than ±1%, surpassing the total number seen in all of calendar year 2017. The recent resurgence of equity volatility coupled with the anticipation of midterm election results has created uncertainty in the outlook for risk assets in the near-term.

While stock prices are ultimately affected by a variety of factors, the fourth quarter has historically yielded the highest percentage of positive market returns compared to other quarters. In addition, market returns following midterm elections tend to be quite strong. Examining S&P 500 returns during midterm election years dating back to 1946, we see that the S&P 500 has never ended the year below its October closing low. The average return over these last 18 midterm elections is +10.6%. Although the sample size for post midterm elections is small, it is reassuring to know that we are in a historically strong period for equity markets.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

So far, October has been a forgettable month for equity performance. Internet and technology companies — once the darling of this rally — have been among the hardest hit, as many investors appear to be taking profits as signs of slower earnings and economic growth have started to appear. Meanwhile, industrial companies have also been hit hard, as trade war rhetoric continues to grow between China and Washington, and China’s GDP growth was its weakest since the financial crisis. Through Wednesday, the materials, energy, industrials, and technology sectors all are in correction territory, with the following losses:

• Materials: -13.0%
• Energy: -12.5%
• Industrials: -11.6%
• Technology: -10.8%

Not surprisingly, volatility — as measured by the VIX index — has skyrocketed as equities have sold off.

More generally, October’s sell-off has been related to the health of the global economy; investors appear concerned about rising U.S. interest rates, a strong U.S. dollar, slowing global growth and trade wars. Only time will tell if October is part of a larger sell-off in global markets and the end of a nine-year bull market in the U.S., or just an anomaly. Going forward, investors will dissect third quarter earnings and be focused on company guidance going into 2019. If growth prospects for 2019 look tepid, many expect this sell-off to continue into year-end and the VIX to remain elevated.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

In 1996, there were more than 8,000 companies listed on U.S. stock exchanges. Today, that figure is less than half. This sharp decline can be largely attributed to the disappearance of many small-cap stocks within the U.S. equity market. Small companies are staying private longer due to rigorous regulatory requirements and prohibitive costs associated with going public. As a result, true small-cap exposure is becoming harder and harder for investors to obtain in traditional equity markets.

Given the strong returns of small-cap equities, many investors have made significant allocations to small-cap equity funds. The inefficient nature and relatively large universe of smaller stocks has historically provided a wide opportunity for investments in companies that are commonly overlooked or underfollowed. When looking at the number of small-cap companies in the Russell 2000 and Russell 3000 index over the past decade, it reaffirms there are fewer attractive small-cap opportunities within the U.S. equity market for investors.

In 2008, the number of small-cap companies (market cap less than $500M) in the Russell 2000 index (small-cap benchmark) were 1,307. Just a decade later, that number has fallen 54% to just 603 companies. A similar trend can be seen in the Russell 3000 index (total market benchmark) with small-cap companies declining from 46% of the index in 2008 to just 20% of the index in 2018.

While attractive small-cap opportunities still exist in the U.S. equity market, true small-cap exposure is becoming more difficult for investors to obtain within their portfolios. If this trend persists, we expect investor capital to continue to seek out private market alternatives for this small-cap exposure.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Our Chart of the Week examines the concentration in market cap over time among the five largest stocks in the S&P 500 relative to the total market cap of the index. With growth outperforming value in the current market cycle, it’s not surprising to see the largest stocks by market cap today populated entirely by growth stocks. The strong performance among FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google/Alphabet) have propelled the weighting of these securities within market cap weighted indices over recent years and caused market participants to question how long this historic run can last and if we are currently in a technology sector bubble. With names such as Facebook and Netflix pulling back earlier in the year and Apple hitting a $1 trillion market cap milestone last week, fears of a technology bubble have only continued.

As of June 2018, the largest five stocks in the S&P 500 occupied 15.9% of the total market cap of the index. This concentration is high relative to the current market cycle, but it is important to note that we are still below the March 2000 high of 18.5%. Additionally, the largest five stocks in the S&P 500 have occupied greater than 20% of the total S&P 500 market cap in prior periods such as during the 1970’s.

The technology sector does trade at a premium to the broader market today. However, the sector generates high return on equity, strong earnings growth, and multiple expansion is not as excessive as during the dot-com peak. While the recent rise in technology stock weighting as a percentage of total market cap warrants monitoring, today’s concentration is not without precedence.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

On November 15, 2017, S&P Dow Jones Indices, a leading provider of financial market indices, and MSCI Inc., a leading provider of research-based indices and analytics, conducted their annual review of the Global Industry Classification Standard (GICS). As a result, the pair decided to broaden and rename the Telecommunications Services sector to the Communications Services sector. The thought process is that over the past several years consumers and businesses have fundamentally transformed the way in which they communicate and access content.

In some ways, this trend started when Comcast, a cable company, announced its intention to purchase a stake of NBC Universal, a television network and content provider, in 2007. The latest example of the convergence between communications and media is the on-going asset fight between Fox, Comcast, and Disney for Sky PLC, a European satellite broadcaster. Moving away from traditional communications and media companies, firms like Alphabet through its Google search engine and YouTube, Facebook through its ever-expanding social media platform, and Netflix through its direct-to-consumer streaming content, have changed the way the world communicates and accesses content. The lines have officially blurred and S&P along with MSCI decided to take action.

What impact will this have on investors?

On September 21, 2018, the Telecommunications Services sector, the smallest sector at a 2% weight in the S&P 500 will quintuple in size to become the fourth largest sector in the index at the expense of the Information Technology and Consumer Discretionary sectors. This change is much larger than GICS’s creation of the Real Estate sector in 2016, which affected approximately 3% of the index’s market cap. Sleepy firms like AT&T, Verizon and CenturyLink will be grouped in the same sector as Alphabet, Facebook, and Netflix, just to name a few. Most notably, a sector classified as 100% value will be primarily growth-oriented.

The composition change is shown in the above chart; the formerly dominant names of AT&T, Verizon, and CenturyLink of the Telecom sector (shown in green) will now occupy a much smaller percentage of the new Communications Services sector, as shown by the considerably smaller blue boxes in the graph.

Luckily, most investment managers select stocks based on their investment merits and not their GICS sector classification. An investment manager that owns Alphabet (Google), which is currently classified as an Information Technology stock, on September 21^st will continue to hold it on September 22^nd. Much like the creation of the Real Estate sector in 2016, there is no action needed on the part of investors. We will continue to monitor new developments as S&P and MSCI finalize the change over the coming months.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.