The word of the day is “Turmoil”
I hope everyone is well and looking forward to the refreshing Fall weather.
Turmoil describes the state of just about everything in the world right now, so I will address directly where we stand and some key developments to watch going forward.
During the third quarter of 2020, the S&P 500 Index gained 8.5%, the NASDAQ Index gained 11.0%, the Russell 2000 Growth Index gained 7.0%, and the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) gained 0.0%.1
Many index and ETF returns are deceiving unless investors understand the underlying composition and method used to determine the returns. Many index and ETF returns are skewed by a small number of the largest tech stocks.
FAAMG (formerly FAANG) companies are driving the stock markets.
The S&P 500 Index’s strength has been fueled by the five FAAMG companies or Facebook, Amazon, Apple, Microsoft, and Google/Alphabet. This is due to their accounting for about 25% of the value of the S&P 500 Index and the Index being market cap weighted. Microsoft, being the “M” in FAAMG replaced Netflix, the “N” in FAANG as being more relevant.
In a recent report from Jones Trading, they estimated that since the end of 2017 with the S&P 500 up 23%, FAAMG accounts for about 72% of that performance, and that 15 companies in the Index account for approximately 96% of the gain, which means the other 485 company’s stock performances were essentially flat.
With that knowledge we can see that some large index and ETF future returns may be in jeopardy for the following reasons:
- A House led committee is calling on Congress to blunt the power of big technology companies, possibly through forced separation of online platforms, as a House panel concludes its Big Tech probe.
- The Senate Commerce Committee moved to compel appearances by Mark Zuckerberg, Sundar Pichai, and Jack Dorsey after failing to reach agreements with the companies to send the CEOs voluntarily.
- The Justice Department is also probing the big four tech platforms and is expected to file a lawsuit against Google.
The silver lining is that many good growth and value companies have been left behind as investors herd into these select few stocks. This is not a new phenomenon as a similar occurrence developed with the Nifty Fifty stocks of the 1960s and 70s and then again in the late 1990s into early 2000 with the internet bubble stocks. History indicates the trend will likely reverse as investor attention eventually will look for new ideas elsewhere.
For investors today there are positives and negatives to note:
Positives:
- It appears that both political parties are in favor of a second-round of stimulus after the November election.
- Continued near zero interest rate environment. In September, the Federal Reserve (“Fed”) stated that it expects to hold short-term interest rates near zero until two things happen: First, the U.S. unemployment rate is back to normal (around a 4.0% unemployment rate) and second, inflation is running at or above 2.0%.
- Census data reported a total of 97,190 business (new) applications for the week ending Sept. 19, representing a 45.1% year-over-year jump.
Negatives
- The government stimulus talks have been halted until after the election
- A contested election outcome or change in political power delays new fiscal stimulus until after Inauguration Day 2021.
- A second wave of COVID-19 could materialize in the US with no adequate policy response and renewed or continued closures.
Stock market volatility remains stubbornly high as investors grapple with a great number of fast changing real issues in addition to an abundance of yellow journalism. My prediction is that much of this confusion may diminish somewhat after the election, but it will not go away due to the amount of contention and divide between the political parties. For either winner, it will be a difficult task to unite the nation.
As for the stock market’s immediate direction, it is anyone’s guess as the senate and presidential election is uncertain. The key to prospering over the long-term is to be a well-read and disciplined investor. Many investors lose by being impetuous and making concentrated investments in intuitively good ideas, but with too little regard to price and details.
In the coming weeks, the corporate report cards will be released during Q3’s earning’s reporting season. It will be interesting to learn the names of the companies which can top the rising tide of Wall Street’ revenue and earnings estimates as well as their expectations for the fourth quarter guidance. These factors give insight into the temperature of corporate management’s view of the future.
During the fourth quarter, I will be concentrating on identifying the companies that demonstrate the opportunity to continue prospering in this dynamic environment.
Lastly, the 2020 elections will likely play a material role in the set-up for future stock market returns.
For investors, the main differences between Joe Biden’s and Donald Trump’s path on the economy and taxes and wages should become clearer.
On the Economy:
Biden cautions against reopening the economy without ramping up the testing. The aim is to combat coronavirus completely.
Trump pushes for the reopening of the economy immediately despite the rise in coronavirus infections in the country.
On Taxes and Wages:
Biden proposes raising the marginal tax rate on the highest income earners. This will help to enhance equality among Americans.
Trump discourages the policy of raising taxes since the economy is struggling. Instead, he has signed an executive order to cut payroll taxes to boost paychecks.
To our existing clients, I extend my sincere thanks for your business. You have our continued commitment to your success. To prospective clients, I invite you to come and grow with us.
Very truly yours,
Martin L. Yokosawa