We are almost through August – roughly seven months since the seemingly remote tremor in Wuhan resulted in the Covid-19 tsunami that would rip through global equity markets just weeks later.
Much like the tragic sequence of events that follows an actual tsunami, the only investors that would escape the carnage were those that immediately ran for the hills. Most of us loitered on the beach, wasting critical moments while our scepticism turned to disbelief as the wave came into view and it became apparent that there was no escape.
And it hit hard. Between February 18 and March 23, the S&P 500 index crashed by over 33% – one of the worst falls in modern history. While the more cyclical sectors were hardest hit, there was nowhere to hide as the immeasurable economic consequences of a global lockdown drove indiscriminate selling.
Then, almost as quickly as the wave came, it subsided. Exactly six months later, on August 18, the S&P 500 officially passed the peak it reached on February 18 2020 to reach an all-time high. Investors, by and large, find themselves confronted with cognitive dissonance as they struggle to reconcile their experience on the ground with the rapid recovery of their investment portfolios.
Understandably, many of our clients are now finding it difficult to build any level of conviction in equities. We would like to offer a view.
A changed landscape
The S&P 500, covering 80% of available US market capitalisation and with $11.2-trillion indexed against it, will always serve as the first, and primary, barometer of risk sentiment. However, to state that the market has now “fully recovered”, while technically correct, would also be to miss a significant tectonic shift in its constitution. A look “under the hood”, so to speak, tells a far more nuanced story.
The broader tech sector has explained 174% of the S&P 500’s 5.9% return year to date. In other words, tech has added 10.23% to the value of the S&P 500. The rest of the market is down year to date, having detracted 4.33% from the S&P 500’s performance.
The divergence between tech shares and the rest of the economy is understandable. Not only have the operations of most tech companies been fairly resilient under lockdown conditions, but many have actually thrived as several secular themes were meaningfully accelerated by the pandemic. Perhaps the best example has been e-commerce penetration in the US, which has increased from 16% to 26% over the past six months. To put this in context, it took US e-commerce penetration 10 years to go from 6% to 16% – that is 10 years of progress in only 24 weeks!
The physical economy, however, has fared much worse. Global blue-chip counters (for instance, Nike, McDonalds, and Starbucks) saw their revenues plummet in 2Q20, with trading conditions only starting to normalise in July. Some have still not seen a return to past year-on-year growth. As we move up the cyclical curve, many companies continue to operate at only a fraction of their normal capacity – and their management teams are far more concerned about survival than growth at the moment.
Given the vastly different dynamics at play in the digital and physical economies, we find it difficult to generalise about the market at this point. Instead, we believe it is important for investors to appreciate the nature of this dichotomy before making any changes to their allocation to equities. In our view, the answer is not to rotate out of the asset class – but rather to rotate within it.