Top Weekly Themes
- Europe Agrees to Spending Plan. Last Tuesday, European Union leaders agreed to a €1.8 trillion ($2.1 trillion) spending package designed to support their economies during the current COVID-19 virus-induced downturn. A noteworthy part of this plan is that financing for the package will come via the issuance of hundreds of billions of euros in debt effectively backed by all member nations. In certain ways, this more closely marries the EU countries to one another, as the EU has never borrowed so much money where the individual member nations have been jointly responsible for the finances of the other members. The agreement came with the strong backing of German Chancellor Angela Merkel, a long-time sceptic of such common financing, who indicated given current circumstances “Europe’s future is at stake.” The package must still be approved by the parliaments of the member nations, but the financial markets voted their approval the same day, as equities finished higher across the continent.
- NASDAQ Surges Higher, Again. The NASDAQ Composite Index, nearly 50% of which is technology-oriented, continued to surge higher again at the start of last week, posting an all-time closing high last Monday. This brought the year-to-date return on the Index to just over 20%. This, as the S&P 500 just recently reclaimed positive territory (now up roughly 1% for the year), while the S&P Mid Cap Index (-9%) and Small Cap Index (-14%) lag far behind. The surge in the NASDAQ has been fueled from the top, with the largest constituents posting outsized returns. The top three holdings in the Index (Apple, Microsoft, and Amazon) account for roughly 30% of the entire Index. Amazon has surged higher by roughly 60% in 2020, with Apple and Microsoft both advancing by better than 25%. Portfolios that, we believe, preserve a more prudent level of diversification have lagged given the concentrated performance dynamics of broad index benchmarks.
- The worst is over. Arguably, much of the move in the technology-oriented stocks has been due to a belief that these companies are better positioned to ride out the unprecedented economic environment caused by the pandemic. Still, the steady move higher in these stocks has them trading for premium valuations, particularly relative to the balance of the market. Conversely, many companies outside the tech sector, which are more exposed to the current downturn, have languished. What will change this dynamic? In a word: earnings. When Coca Cola announced quarterly results last Tuesday, they indicated the worst was over as it relates to the impact of the recent shutdown. As earnings season moves into full swing over the coming days, we will be intently listening to comments from other non-tech companies for indications of when a return to earnings growth is likely. For perspective, S&P 500 Value Index earnings have a 0.91 correlation with overall S&P 500 earnings, while S&P 500 Growth Index earnings only exhibit a 0.66 correlation. The cyclical nature of value stocks versus the more idiosyncratic nature of many growth businesses means that an overall improvement in corporate earnings will be a key component of any rotation away from large cap growth and tech.
|Week (%)||YTD (%)||1-Year (%)||3-Year (%)||5-Year (%)||Div Yield (%)|
|Russell 1000 Value||1.4||(12.0)||(5.6)||9.9||31.4||2.64|
|Russell 1000 Growth||0.2||14.5||24.6||70.1||111.4||0.83|
|MSCI EM (Emerging Markets)||3.1||(1.7)||5.0||10.5||33.9||2.56*|
|Bloomberg Barclays US Aggregate||0.4||7.4||10.1||17.5||24.5||1.13|
|Bloomberg Barclays US High Yield – Corporate||1.6||(0.2)||3.5||13.5||32.3||5.59|
|Bloomberg Barclays Municipal Bond||0.4||3.4||5.2||13.7||22.1||1.28|
|Bloomberg Barclays Global Aggregate x US (Country)||1.2||3.6||4.8||9.6||20.5||0.71|
|Crude Oil WTI (NYM $/bbl) Continuous||0.8||(32.7)||(27.7)||(10.3)||(15.2)||41.1|
|Natural Gas (NYM $/mmbtu) Continuous||3.6||(18.5)||(22.4)||(39.9)||(36.6)||1.8|
|Gold NYMEX Near Term ($/ozt)||5.0||24.3||33.0||50.6||72.7||1,889.1|
|Copper Cash Official LME ($/mt)||2.3||6.1||9.5||8.9||22.4||6,533.5|
|1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.14||1.12||1.12||1.17||1.10||1.16|
|Japanese Yen per U.S. Dollar||107.12||108.68||108.12||111.13||124.04||107.00|
|U.S. Dollar per British Pounds||1.26||1.32||1.24||1.30||1.55||1.27|
As of July 23, 2020 (close) *Dividend Yield For MSCI EAFE and MSCI EM are from 5/29/2020.
Chart of the Week
CONCENTRATION, CONCENTRATION…the S&P 500 Index
- By design, the S&P 500 Index should provide a diversified exposure to U.S. companies across many industries. Like most indices, however, it is market cap-weighted. This simply means the bigger the company’s market capitalization (shares outstanding x stock price), the bigger the impact the company has on the performance of the Index. Given these dynamics, and the run-up in certain technology-related companies, the Index is becoming more and more concentrated in a small number of stocks.
- As the graph above displays, over the past roughly six years, the weight of the top five stocks within the Index has roughly doubled and now stands at a 30-year high. The two largest holdings, Microsoft and Apple, each have weights of roughly 6%.
- The lopsided nature of the Index is further evidenced by the fact that the top five holdings have a combined weight which is greater than the aggregation of the bottom 350 companies.
- The math (from within the past few weeks) detailed in the second graph is particularly eye-opening as to 2020 performance. While the S&P 500 Index itself was roughly scratch for the year, the bottom 495 constituents generated a collective loss of over 7%. Conversely, the top five names (Apple, Microsoft, Amazon, Facebook, and Alphabet) advanced 32%, enough to offset most of the 7% loss registered on the bottom 495 names within the Index.
- Clearly, any investor without exposure to these five stocks, and at their outsized weights within the Index, has been swimming against the tide in 2020. While the S&P 500 may well be an Index of 500 stocks, it is currently far from the diversified investment vehicle that most investors would generally consider it to be.
Life for the Euro, a Tailwind for International Markets
The MSCI EAFE Index has underperformed the S&P 500 over the past decade. The underperformance is particularly pronounced for the trailing three years ending June 30, 2020, with the S&P 500 generating an average annual return of 10.7%, versus just 0.8% for the EAFE Index. The reasons for underperformance vary, but EAFE’s lower weight to technology stocks has certainly had an outsized impact. Another recent headwind has been the strength of the U.S. dollar, which effectively erodes the value of a domestic shareholder’s non-dollar denominated investments.
The chart above shows the value of the euro relative to the U.S. dollar for the trailing three years. For most of this time period, the euro has moved steadily lower. Within the past two months, however, the trend has changed, with the euro showing notable strength relative to the greenback. One reason for the recent strength of the U.S. dollar, relates to the fact that money tends to flow where it is best treated from a yield perspective. For much of the three-year time period, interest rates were notably higher in the U.S. than in Europe. While that dynamic still exists, the disparity has been greatly reduced given the recent moves by the Fed to reduce short-term rates to near zero.
Within our equity strategies, we have client portfolios positioned with meaningful exposure to developed international equities, believing the premium valuations accorded to domestic equities relative to international issues had become too extreme –a fact we have touched on in various commentaries. If the recent change in trend for the euro persists, it would provide an added boost for foreign equity investments. While two months certainly does not a trend make, after almost three years of ceding ground to the dollar, a stronger euro would be a welcome change for holders of international equities.
Fundamentally, there are reasons to believe current dollar weakness will continue. Per BCA Research, “the greenback is more likely to depreciate than appreciate. Certain headwinds for the dollar include:
First, the dollar is a strongly countercyclical currency and a global economic recovery where China’s credit impulse is accelerating often spells trouble for the USD. Second, the U.S. balance of payment picture is deteriorating because the U.S. twin deficit is exploding. Third, even though the U.S is issuing more liabilities, real interest rate differentials are moving against the USD. The cost of hedging USD assets has also collapsed, thus investors buying U.S. assets are less likely to do so without hedging than they did in recent years.”
 BCA Research Daily Insights. July 21, 2020.