A Tale of Two Markets

What is the market? In the investment world and in the popular financial press, the term “market” is used fluidly. How often do we hear, “The market was up today,” or “Why was the market down today?” Is the market the Dow? The S&P 500? The Nasdaq? Or is it some even broader entity that captures stocks not just in the United States but all over the world?

While there might not be consensus on how to define the “market,” we can undoubtedly agree that 2020 has been an extraordinary year for markets – both globally and in the US. After dropping precipitously in the first quarter, stocks rebounded quickly in the second quarter and continued to surge over the summer. In fact, the bear market was the shortest in history at just over a month in length.

Although the US stock market in the aggregate recovered nicely, the recovery hasn’t been experienced uniformly. As this chart shows, the 5 largest stocks in the S&P 500 (Apple, Microsoft, Amazon, Google and Facebook) were up over 60% through August while the other 495 stocks in the index were down 5.5% collectively. Furthermore, 140 stocks in the S&P 500 were still in bear market territory (down 20%+ from their highs). The tech-heavy NASDAQ was up over 32% for the first eight months of the year while the Dow was up just over 1% and international stocks fell 4.6%. A tale of two markets for sure!

When looking at this breakdown of “the market,” diversification doesn’t seem to be much help. Why not load up on the biggest stocks – the tech giants – and call it a day? Certainly, if one had done that at the beginning of the year, it would have been a genius move. But, as they say, what goes up, must come down. We saw a microcosm of this Thursday, Friday, and Tuesday when those 5 largest stocks lost over $1 trillion in market cap over a three-day stretch. And Tesla, a recent tech darling, especially following its recent stock split, experienced its single largest one day drop in the company’s history – falling 21%!

Diversification Matters

And often, it matters most when everything in the market seems to indicate differently. As this chart shows, the spread between the best performing sector (technology) and the worst performing sector (energy) hasn’t been this large since the late-1990s. And we know that what followed that period was an absolute bloodbath for technology stocks. And while the tech giants of today are different than the high-fliers of 1999, it is still the case that those companies are extremely expensive. Apple is trading at over 30x earnings while Amazon is trading at over 140x earnings! Even if those companies continue to be incredibly successful, that success would not support those lofty valuations. And, while the last few trading days may have been a head fake, they did illustrate how vulnerable these stocks can be if investor appetites change.

What does this mean for you? As we often say, being diversified is one of the keys to building and maintaining long-term wealth. Your portfolio has a healthy allocation to those top-5 names but also has exposure to the thousands of other stocks in the market. This way, your portfolio is well-positioned for the future no matter which stocks lead the way.

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Past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk.  Future performance of any investment or wealth management strategy, including those recommended by Balasa Dinverno Foltz LLC (BDF), may not be profitable, suitable for you, prove successful or equal historical indices.  Historical indices do not reflect the deduction of transaction, custodial, investment management fees or fund fees which would diminish results.  Any historical index performance figures are for comparison purposes only and client account holdings will not directly correspond to any such data.  BDF clients must, in writing, advise BDF of personal, financial or investment objective changes and any restrictions desired on BDF’s services so that BDF may re-evaluate its previous recommendations and adjust its investment advisory services.  BDF’s current written disclosure statement discussing advisory services and fees is available for review at www.BDFLLC.com or upon request.

All Indexes are unmanaged and individuals cannot invest directly in an index.  Index returns do not include fees or expenses. 

S&P 500 – The S&P 500 Index includes a representative sample of the largest 500 companies in the U.S.

Dow – The Dow Jones Industrial Average is a stock market index that tracks 30 large, publicly owned blue-chip companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.

Russell 2000 Index (R2000) – The Russell 2000 Index^® measures the performance of the 2,000 smallest companies in the Russell 3000 Index.

MSCI EAFE Index USD (EAFE) –  The MSCI^® EAFE (Europe, Australia, Far East) Net Index is a benchmark in the US to measure international equity performance. It comprises 21 MSCI country indexes, representing the developed markets outside of North America measured in U.S. dollars.