This report features world capital market performance and a timeline of events for the past quarter. It begins with a global overview, then features the returns of stock and bond asset classes in the US and international markets. The report also illustrates the impact of globally diversified portfolios and features a quarterly topic: Market Review 2020: Looking Back on an Unprecedented Year.
Client Question of the Week:
Should I be concerned about the recent underperformance of small and value companies?
When you go through a time period like we have gone through recently where value has underperformed growth, and small caps have underperformed large caps, it's natural for people to want to question if they should change their asset allocation. However, getting past the recency bias and understanding that we want to make investment decisions based on probabilities rather than possibilities may lead to a better investment experience.
Taking a step back, we know that both the value and size premiums are rooted in sound economic theory. All else being equal, companies with lower relative prices (value stocks) and lower market capitalization (small cap stocks) should have higher expected returns. In addition to being economically sensible, these premiums are supported by a preponderance of evidence spanning nearly a century in the US and more than five decades in non-US markets.
While we wake up every day and expect positive value and size premiums, we understand there is volatility associated with pursuing these premiums. Exhibit 1 shows the percentage of 1-, 5-, 10-, 15-, and 20-Year periods with negative premiums in the US equity markets through December 31, 2019. As illustrated below, there will be times when we experience negative premiums, but as an investor, you need to determine if you want to make a decision that has a high probability or low probability of success.
Emerging markets are an important part of a well-diversified global equity portfolio. However, recent history reminds us that they can be volatile and can perform differently than developed markets. In this article, we provide a longer historical perspective on the performance of emerging markets and the countries that constitute them. We also describe the emerging markets opportunity set and how it has evolved in recent years.
RECENT PERFORMANCE IN PERSPECTIVE
In recent years, the returns of emerging markets have lagged behind those of developed markets. As shown in Exhibit 1, over the past 10 years (2010–2019) the MSCI Emerging Markets Index (net div.) had an annualized compound return of 3.7%, compared to 5.3% for the MSCI World ex USA Index (net div.) and 13.6% for the S&P 500 Index. While recent returns have been disappointing, it is not uncommon to see extended periods when emerging markets perform differently than developed markets. For example, just looking back to the prior decade (2000–2009), emerging markets strongly outperformed developed markets, with the MSCI Emerging Markets Index (net div.) posting an annualized compound return of 9.8%, compared to 1.6% for the MSCI World ex USA Index and –0.95% for the S&P 500 Index.
Market Returns and Election Years
On November 3rd, millions of Americans will cast their vote for the next President of the United States. Although the outcome of the election is uncertain, one thing we can count on is that plenty of opinions and prognostications will be floated in the months leading up to Election Day. In financial circles, this will almost assuredly include perceptions and opinions of market impacts. But, should long-term investors focus on presidential elections?
It is natural to draw a connection between the administration in power and the influence they may have on markets. However, we would caution investors against making short-term changes to a long-term plan to try to profit (or avoid losses) from changes in the political landscape. The 2016 presidential election serves as a recent example of the risks associated with trying to forecast market movement based on election results. There were a variety of opinions about how the election would impact markets, but many articles at the time posited that stocks would fall if Trump were elected. One article went as far to say, "Wall Street is set up for a major crash if Donald Trump shocks the world on Election Day and wins the White House." Yet, despite President Trump being in office, along with ever-present uncertainty arising from a host of events including the Brexit vote, negative interest rates, trade wars, and geopolitical turmoil in the Middle East, to name a few, the markets reached all-time highs prior to COVID-19.
Why Investors Should Think Twice Before Focusing Their Investments on a Handful of Very Large Technology Companies
Client Question of the Week:
It seems that the world is changing and this crisis has cemented the dominance of a handful of very large technology companies (FAANG). Given their scale and recent outstanding performance, why shouldn't investors just focus on them?
- The stocks commonly referred to by the FAANG moniker—Facebook, Amazon, Apple, Netflix, and Google (now trading as Alphabet)—have posted impressive gains through the years, and recent strong performance in light of a struggling economy has caused some to question if these large tech companies will continue to dominate the market.
- Investors may be surprised to learn that it is not unusual for the market to be concentrated in a handful of stocks. As we see in Exhibit 1, the combined market capitalization weight of the 10 largest stocks, just over 20% at the end of last year, has been higher in the past.
- Additionally, technological innovation dominating the stock market is not new. While the definition of “high-tech” is constantly evolving, firms dominating the market have often been on the cutting edge of technology. AT&T offered the first mobile telephone service in 1946. General Motors pioneered innovations such as the electric car starter, airbags, and the automatic transmission. General Electric built upon the original Edison light bulb invention, contributing to further breakthroughs in lighting technology, such as the fluorescent bulb, the halogen bulb, and the LED. So technological innovation dominating the stock market is not a new normal; it is an old normal.
It seems like a day doesn’t go by without Tesla’s rocketing stock price capturing headlines. How can investors make sense of the looming threats related to COVID-19 and an economic downturn versus a stock market that has positive returns so far this year? Through July 20, the S&P 500® Index and Russell 3000® Index are each up between 1-2% year-to-date.
If we break down the market further into components, growth stocks have been the clear winner. Consider the year-to-date performance for size and style groupings in Figure 1. Large-cap growth stocks have beaten large value stocks by more than 30% and small-cap value stocks by more than 40%.
Tech standouts are drawing attention for their perceived sway on stocks, but history undercuts that view.
A top-heavy stock market with the largest 10 stocks accounting for over 20% of market capitalization and a marquee technology firm perched at No. 1? This sounds like a description of the current US stock market, dominated by Apple and the other FAANG stocks,1 but it is actually a reference to 1967 when IBM represented a larger portion of the market than Apple at the end of 2019 (5.8% vs. 4.1%).
As we see in Exhibit 1, it is not particularly unusual for the market to be concentrated in a handful of stocks. The combined market capitalization weight of the 10 largest stocks, just over 20% at the end of last year, has been higher in the past.
How can investors make sense of the apparent disconnect between stock market performance and economic indicators?
Do you find it puzzling when a bleak economic report emerges from the press, only to be accompanied by a positive surge in the stock market? You’re not alone. The last few weeks have produced many examples of a stark contrast between stock market performance and economic indicators. So why the apparent disconnect?
Markets are forward-looking, meaning current asset prices reflect market participants’ aggregate expectations. Those expectations include whatever future economic developments are anticipated and their potential impact on cash flows, which are key to a stock’s value. For example, if the market expects the economic environment to weaken company cash flows, stock markets may react well in advance of when we observe the impact on cash flows, as expectations are embedded in prices. And the eventual direction of the stock market will depend on how the economic outcome compares to expectations. If things aren’t as bad as expected, poor economic news can be greeted with a positive stock reaction.
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