Ever since stocks began to rebound from the March bottom, there has been a glaring disconnect between the impact of the coronavirus on the economy and the good mood of the stock market. Eight months later, that disconnect is as wide as ever. If one only looked at the markets, it would be difficult to tell that anything was amiss.
Investors remain in a bullish mood while the economy continues to deal with the surging spread of the coronavirus, new lockdowns in California, increased unemployment claims and a lack of stimulus from Congress for those who remain out of work. While economic numbers tell the story of the past, the stock market’s focus is on the future. The markets are not ignoring the news of the day, they simply are looking beyond it —focusing on a low interest rate environment for the next several years, a vaccine rollout that will allow the economy to reopen in 2021, a new political administration and an additional stimulus package.
It is generally understood that day-to-day market swings do not reflect what is going on in the true economy, although it may feel like they should. There are some fundamental differences between the two which can be exacerbated in short time periods, but over the long run, the stock market and the economy do tend to have a stronger correlation.
At the most basic level, the economy is the production and consumption of goods and services. It encompasses all individuals and companies, as well as the government. The stock market, however, is an exchange where the buying and selling of shares of publicly traded companies occur. Stocks trade based on future earnings; they are forward-looking in nature. The earnings expectations for the top large-cap companies are high, and we should expect these companies to face volatility in the near future with growing regulatory pressure, ad-spending boycotts, the upcoming runoff election and potential corporate tax changes.
Small businesses are known to be the lifeblood of the U.S. economy, but they do not represent the stock market. According to the U.S. Small Business Administration, small businesses make up about half of private sector employment and 44% of U.S. economic activity. They represent over 99% of U.S. employer firms and create two-thirds of new jobs.
Less than one third of Americans work for publicly traded companies. That means the U.S. stock market represents only a portion of U.S. employment and does not entirely reflect how economic gains are distributed throughout the economy. The composition of the stock market also is different from the real economy. We see this in the weighting of major indexes, like the S&P 500, in that the largest stocks have the biggest influence. Right now, the largest five companies, all of them growth technology companies, make up 25% of the S&P 500.
So, what can we learn from all this?
Basing investment decisions on the current economy instead of where it is headed can often lead to incorrect assumptions about the direction of the stock market. Trying to time the market is extremely difficult and can cause poor investment performance. As we near the end of 2020, we view more risk being out of the market than in the market. Riding out future market volatility, in addition to having a diversified portfolio, means staying the course.
It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. With regards to investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals – regardless of market volatility. Long-term fundamentals are what matter.
This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.
S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. The Dow Jones Industrial Average is a popular indicator of the stock market based on the average closing prices of 30 active U.S. stocks representative of the overall economy. NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The Russell 2000 Index (RTY) measures the performance of the small-cap segment of the U.S. equity universe. The MSCI EAFE Index (MXEA) is an equity index which captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the US and Canada. The S&P 500® Value Index (SVX), represents the value companies, as determined by the index sponsor, of the S&P 500 Index. The Index measures the performance of large-capitalization value companies in the United States. The MSCI Emerging Markets Index (MXEF) captures large and mid cap representation across 26 Emerging Markets countries. The NASDAQ-100 Index (NDX) is made up of 103 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market. It is a modified capitalization-weighted index. The S&P 500® Growth Index (SGX), represents the growth companies, as determined by the index sponsor, of the S&P 500 Index. The Index measures the performance of large-capitalization growth companies in the United States. It is not possible to invest directly in an index.
Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. Kestra IS and Kestra AS are not affiliated with CD Wealth Management.