Quote of the Week
“Don’t let yesterday take up too much of today.” Will Rogers
I must say I am baffled at the resilience of the markets since hitting the low in March of this year. Usually, after in a big market drop at the beginning of a recession, we get a “bear market bounce.” But this time, the economy is in a depression and is taking a much greater hit than during a normal business cycle recession. All the data points to a terrible economic outcome from the virus going forward.
At least half of all households have experienced some level of income loss. Mortgage delinquencies saw their largest monthly increase ever in April, effectively doubling from 3.4% to 6.5%. Roughly 9% of mortgages (more than 4.7 million loans and greater than one trillion nominal loan value) are currently in forbearance. Fifteen million and three million people are in credit card and auto loan forbearance programs respectively totaling more than 3% of all credit card accounts and 3.5% of tracked auto loans. There is simply no good news.
I can’t predict the future; however, if history is any indication, the markets won’t hold up. We are putting our faith in the data and the mathematics, so we are remaining conservative. We manage your investments to mitigate the “big loss.” Gravity should eventually prevail.
Speaking of not understanding things, I watched some of the national news shows over the holiday weekend. I could not believe (yes, I can) the stupidity of some of the people at the beaches in Louisiana, Mississippi, Florida, and South Carolina, plus the pool party in the Ozarks. The pictures of the people elbow to elbow without masks were tragic. The interviews of the people were unbelievable. Ignorance can be cured, but stupidly is hopeless.
This virus is extremely contagious, which brings to mind the chorus of 62 people where one person infected 58 of the members in one practice session. Imagine a major flareup happening this summer before the expected increase during the fall and winter.
Welcome to the S&P 5 Index
The five biggest companies in the S&P 500 are Microsoft, Apple, Amazon, Google, and Facebook. Combined, they make up 23.48% of the Index’s entire market cap.
That’s higher than back in 2008, when the five biggest companies made up about 15%. And it’s higher than right before the dot-com bubble burst in 2000. Back then the five largest components of the index made up 18% of its total market cap. That means, when you see the S&P 500 rallying, it’s because the five stocks are heading up and pulling the whole index with it.
Don’t believe me?
Well, consider the fact that the S&P 500 is just 10% below its all-time high, set in February. Then compare that to the fact that the average component stock is still 21% below its high. Now, do you see the disconnect?
In an ideal world, all stocks go up together and everyone is happy. The current Covid-19 environment is far from ideal. Market breadth is as bad as it’s been in years.
Breadth is an indicator that measures how many stocks are moving up compared to the number that are falling. When a market has narrow breadth, it means that a small group of stocks is driving the upside in the market while the majority are falling.
Narrow market breadth has proceeded both the recent recessions in 2000, 2008, and in 1990. And the market breadth narrowed before both the economic slowdowns in 2011 and 2016.
How Long Can It Last?
The short answer to the question, “How long can this Last?” is a while. Market breadth was very narrow and investors were crowding into just a few top stocks in the 27 months between 1998 and the dot-com crash of 2000.
But historically, that was the longest and an outlier. In statistics, you drop the outliers and focus on where the majority of the numbers fall. And that is about three months.
We’re already about through a month and a half. That means this is likely to last another two months or so before the mega-cap concentration backfires for investors. Though it is a short window of time, this week it is already starting to happen. Even if it lasts longer than the average three months, it always works itself out in the same way for the companies propping up the market: with big losses.
Basically, the market leaders will ultimately fail to generate earnings strong enough to justify their sky-high valuations and all the investors who are crowding into those stocks. And then one of two scenarios will play out. Neither of them is good for investors betting on the big leaders.
Either the laggards catch up with the leaders as improving economic outlook and strengthening investor sentiment drives money into those stocks while the prior leaders lose momentum. Or the opposite happens. Instead of the losers catching up with the winners, the leaders “catch down” to the losers. I know which one we are betting on.