The last few weeks have been pretty volatile and it looks like today will be more of the same. The S&P 500 index is still up 1.89% for the year as of the last market close (9/18/2020). On the other hand, the DJIA is down -4.20% for the year. The difference in returns is easy to explain. Basically, there is a small group of companies that are thriving despite the recession.
The S&P 500 index is capital weighted. That means the index holds a proportional amount shares based on a company’s value. Just five large companies make up roughly a third of the index’s value. Those companies are Microsoft, Amazon, Google, Facebook, Netflix and Apple. With the pandemic forcing people to shelter in place, the tech sector has been rewarded.
That does not mean we should expect to see the tech sector to continue to outperform. Fidelity recently compared the performance gains to the top 10 companies in the S&P 500 against the bottom 490. The chart below shows the divergence in performance since the pandemic began. It also shows that the best performers tumbled by 12% from their most recent peak. The other 490 investments only declined by 4%.
We have seen multiple market corrections during the last few years. My premise going into 2020 was that this year would be much more volatile considering the coming election. The pandemic added further strain to an already fragile system. The Federal Reserve has responded by injecting trillions into the U.S. economy. While this has stabilized things somewhat, we’re left with 0% interest rates for savings accounts and the U.S. Dollar quickly losing value.
Despite the negative news, it is still best to remain invested for the long term. The quick correction in March illustrates why investors should stay the course. This means sticking to a diversified strategy rather than trying to get ahead of the market. The handful of top performing companies may or may not continue to outperform.
In June, I added a small amount of technology-oriented stocks (QQQ) , but I also increased positions in short term bonds, commodities and added a Euro denominated money market. This was an incremental change rather than an overhauling of each portfolio. It appears that other investors did the same. ETF inflows during the second quarter show an increase in fixed income (bonds) and commodities. The consensus during the last quarter seems to be that a move towards safety is prudent.
Even before the pandemic, financial professionals were worried that the Federal Reserve was creating an asset bubble. One prominent fund manager pointed out many of the concerns I’ve voiced over the last year and came to the conclusion we’re in a ‘Rolling Depression’. On the other hand, he points out that the Fed had little option other than to inject liquidity into the market. I tend to agree with that point. During the Great Recession, economists begged for this kind of intervention.
I do not plan on making any major market moves until after the election this year, though I will continue to dollar cost average into the market monthly while rebalance portfolios each quarter. I would not recommend changes in self-directed accounts at this time. Those portfolios were built with a downturn in mind.
Investors are in the most difficult position they’ve been in since 2007. There’s no point taking on more risk than you need in the near term. To illustrate that point, my cousin recently reached out to me very excited about his first stock purchase last month. He bought a share of Tesla at the beginning of the month for about $500. His investment lost 30% of it is value within a week. The point here is that it’s really easy to lose money when you’re following the hype.