Who can ever forget the Muppets’ “Alphabet Song” on Sesame Street? “B” is for Bert. “C” is for Cookie Monster. Certainly not Wall Street pundits, who debated which letter would best describe the path of the eventual post-COVID recovery.
Would it be a “V” (sharp decline-sharp rebound), “W,” “U,” “L,” or even a “Nike Swoosh?”
The letter “K” is a vertical line with two 45-degree lines slanting from the middle, one upward and one downward, and unfortunately best describes the paths of the economy and stock market since the nadir (hopefully) of the COVID pandemic in March. The gap between the “haves” and “have-nots” has further widened over the intervening six months, resulting in the “haves” having more (sometimes much more) and the “have nots” having less (oftentimes much less).
The “happy,” upward-slanting line symbolizes those parts of the economy that actually benefitted from the pandemic.
Technology companies like Apple and Zoom gained from the massive, instantaneous switch to “work from home (WFH).” Netflix kept us entertained. Target and Walmart sold copious amounts of household staples. Home Depot and Lowe’s gained as folks decided to fix-up their homes. Amazon continued to grab market share from bricks and mortar competitors.
Not surprisingly, the Direxion Work From Home ETF (Ticker: WFH) was recently launched to make it easy for the Robinhood crowd to jump on the bandwagon with a single click.
The “sad,” downward-slanting line symbolizes pretty much everything else.
The list of companies hurt by the pandemic is much longer and contains a boatload of bankruptcies, with more sure to come. For retailers that were already teetering like J.C. Penney, Pier One and Brooks Brothers, the pandemic was just the final straw. Any business dependent on physical customers, like airlines, hotels and restaurants, is facing a genuine existential crisis.
The situation is even more dire for small, privately-held businesses, which employ the majority of Americans. Yelp reported that as of the end of August, 163,735 businesses indicated they were closed, up 23% from July. Further, the National Restaurant Association said at least 100,000 restaurants are closed (nearly one in six) and 3 million restaurant employees are without a job. Alarmingly, with cold weather approaching, 40% of owners surveyed said they are likely to close within six months without additional government support.
On Feb. 19, the S&P 500 reached a record high. As the government effectively shut down the economy in an attempt to contain the pandemic, panic ensued, with the S&P 500 plunging 34% over the next five weeks. Incredibly, by Sept. 2, the S&P 500 made a new record high, as investors seemingly put COVID in the rearview mirror.
How can you reconcile the disconnect between the joy on Wall Street and the continuing pain on Main Street?
First, there is an old investing adage, “don’t fight the Fed,” which means if the Federal Reserve wants to support stocks with lower interest rates (like now), stock prices are unlikely to act contrary.
Second, the lower the interest rate, the higher the multiple of earnings investors are willing to pay, resulting in higher stock prices. Further, with bond yields approaching zero, investors are facing the reality of TINA, or There is No Alternative (to stocks). The Fed is forcing investors into riskier assets.
Third, this is one of those times the S&P 500 is a terrible proxy for the performance of the “average” stock. The S&P 500 is a capitalization-weighted index, which means the performance of the largest-capitalization (i.e. stock price times number of shares outstanding) stocks impact index returns much more than the smaller-capitalization stocks.
For instance, Apple recently became the first U.S. company to attain a market capitalization of $2 trillion, more than the total market capitalization of the entire Russell 2000 small-capitalization index. Indeed, the “Fab-Five” largest-capitalization stocks in the S&P 500 (i.e. 1% of the stocks) — Apple (up 76% year-to-date (YTD) through August), Amazon (87%), Microsoft (43%), Google parent Alphabet (22%) and Facebook (43%) — recently had a combined index weight of 23%, the highest concentration in 30 years.
Indeed, while the S&P 500 had a total return of 9.7% YTD through August, the version of the S&P 500 that gives an equal 0.2% weight to each of the 500 stocks had a total return of minus 2.3%.
Clearly, the massive gains in the mega-capitalization technology stocks have masked weakness in low-index weight sectors that have been decimated, like Energy (2.3% weight — down 40%), which simply don’t register.
Mickey Kim is the chief operating officer and chief compliance officer for Columbus-based investment adviser Kirr Marbach & Co. Kim also writes for the Indianapolis Business Journal. He can be reached at 812-376-9444 or [email protected] or send comments to [email protected].