“None of this makes sense” – Everyone, circa 2020
On the morning of July 30, 2020, the Commerce Department announced that US economic growth declined by 33%, on an annualized basis. That’s a number that far exceeds anything we have ever seen in this country. In other words, April through June of 2020 was the worst quarter for economic growth in US history. It’s worth also noting that unemployment jumped from historic lows of around 3.5% in Q1, to nearly 15% in Q3. Another all-time record. And not the good kind.
So how is it that on that very same morning, the S&P 500 opened just 4% below it’s all-time high, after rallying nearly 50% in only 4 months, including the best 50-day period for US stocks EVER?!
Good question. Let’s talk about a couple of ways something that seems to make no sense at all right now on the surface, could actually make all the sense in the world.
The stock market is not the economy
You may have heard this phrase recently. Maybe even from us. Whether it’s the media or our favorite or most loathed politician, we’re made to believe that the performance of the stock market is an appropriate measure for the health of our economy at any given moment. In reality, it’s just not that simple.
The stock market is a forecasting mechanism. It is always forward-looking. The reality is that the day-to-day movements of the stock market are based mainly on how investors believe recent news will ultimately impact future earnings of publicly-traded companies. On the other hand, all economic data that is released to the public is based on what has already happened, not what lies ahead.
Since this particular economic crisis is somewhat self-imposed and there is broad consensus that an inevitable vaccine will eventually lead us out of it, investors seem to be looking past the initial uncertainty which caused the crash in stock prices we experienced in March. Although the actual economy is in terrible shape at the moment, investors generally aren’t putting their money to work for an immediate return. True investing is a long-term journey. Many long-term investors have likely seized on the opportunity to put more of their money to work in the market at (somewhat short-lived) lower valuations – generally a pretty good move from our perspective.
“The market” might not be what you think it is
Stating that the S&P 500 is within 4% of its all-time highs can be a bit misleading. What many people don’t realize is that the S&P 500, while widely used as THE benchmark for US Large Cap stocks, is not exactly representative of the whole US stock market.
To no one’s surprise, there are 500 companies represented by the S&P 500 index. Yet, because it is a market cap weighted index, the 5 largest companies make up more than 20% of the index. In other words, the performance of FaceBook, Amazon, Apple, Microsoft, and Google, account for 20% of the performance of the index as a whole. So while those 5 companies are up over 35% on the year so far, the other 80% of companies represented by the S&P 500 are still negative on the year.
Not to be a downer, but the investor outlook isn’t as rosy right now for the vast majority of US businesses as this most popular market benchmark might indicate.
What does all of this really mean for long-term investors?
Diversification matters. It’s very easy to fall into the performance-chasing trap of finding a single investment or asset class that has performed well recently relative to your portfolio and shift everything into it.
Recency bias is the tendency for investors to assume that recent performance will translate into future performance. Unfortunately, succumbing to this bias is one of the most detrimental mistakes long-term investors can make.
2020 will no doubt be a year that ends up providing numerous examples that reinforce the importance of having a long-term strategy and sticking to that strategy, rather than letting emotions take the wheel.
At blooom, we believe an appropriate long-term strategy involves broad, global diversification. In the entire history of the stock market, it has never made much sense or been predictable in the short-term. Investors have been searching for a crystal ball, unsuccessfully, since the beginning of time. Even considering the perpetual uncertainty of the stock market, we can’t think of a single year that has ever highlighted the importance of having a personalized investment strategy, more than 2020.
Here’s to a better second half!
The information is provided for discussion purposes only and should not be considered as advice for your investments. Investors should consider their ability to continue investing through periods of fluctuating market conditions.
Published on August 17, 2020