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Blog | The Portfolio Doctor

The Portfolio Doctor

My blog provides valuable insights into Nobel Prize-winning financial strategies for investors. By utilizing decades of worldwide peer-reviewed capital markets research and analysis, I demonstrate how to build better investment portfolios with lower risks. I also examine common financial media misinformation and how investors can make better financial decisions.

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.

 

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Can Growth Stocks Get Growthier? An Update on Valuations

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%.

 

Figure 1

 

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Large and In Charge? Giant Firms atop Market is Nothing New

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.

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Under the Macroscope: When Stocks and the Economy Diverge

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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Could 'Flying to Safety' Be Dangerous?

When markets turn volatile and uncertainty rises, it’s common for investors to flock to what they perceive to be safer assets. Despite well-documented perils to such market-timing maneuvers, it can be tough to overcome the urge to get out of the market and wait on the sidelines until markets return to “normal.” (Professor Amit Goyal discusses the potential shortcomings of market-timing strategies here).

Flows into money market funds indicate many investors have again flown the coop since the current market downturn began in late February. Government money market funds (MMFs) are a popular destination for investors seeking a “safe” port, andFigure 1shows that more than $1 trillion has poured into the category since February 19. By way of comparison, government MMFs experienced year-to-date net outflows of more than $30 billion before the downturn. While we don’t know exactly where the money came from, we believe it’s safe to assume that a significant portion came from equities.

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The Fed’s Balance Sheet: The Other Exponential Curve

 

As the threat of COVID-19 keeps millions of Americans locked down at home, businesses and financial markets are suffering.

For example, a survey of small-business owners found that 51% did not believe they could survive the pandemic for longer than three months. At the same time, the S&P 500 posted its worst first-quarter on record.

In response to this havoc, the U.S. Federal Reserve (the Fed) is taking unprecedented steps to try and stabilize the economy. This includes a return to quantitative easing (QE), a controversial policy which involves adding more money into the banking system. To help us understand the implications of these actions, today’s chart illustrates the swelling balance sheet of the Fed.

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Scams Abound Amid Pandemic Panic

Computer Code

Sadly, as is the case in any crisis, there are those among us who are looking to capitalize on cruelty and take advantage of heightened vulnerabilities. Hackers are trying to lure victims to click on COVID-19 related hyperlinks that contain malicious software and other computer viruses. In some cases, these scams look like official messages from the government and they send people to fake websites where their sensitive information can be stolen.

The following guidelines can help you protect yourself from these digital scams and stay clear of suspicious links you may come across in your internet travels.

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CARES Act Signed into Law –Brings Relief to Millions of Americans

On March 27 the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to address the unprecedented public health and economic crisis related to COVID-19.

This $2 trillion bill is meant to impact both individuals and businesses and contains significant tax-savings measures. It could affect prior tax years while also creating immediate cash-flow.

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