At the outset of the COVID-19 pandemic back in late February and early March, economic prognosticators were already trying to forecast what type of recovery we would have in the United States. For visual reasons and simplicity, a popular approach of picking letters of the alphabet to represent the recovery emerged. Optimists suggested a V-shaped recovery where economic activity would drop off due to lockdowns but recover quickly. Cautious observers thought a U-shaped recovery was more likely, a slower fall and slower rise. Pessimists were calling for an L-shaped recovery, where the economy went down and did not recover for a long time. For reference, most of these prognosticators would agree the global financial crisis from 2008 fell somewhere between a U and an L.
Status of the Current Recovery
Today, six months into the pandemic, the popular consensus seems to be that we are experiencing a K-shaped recovery. This tweet back in April summed it up: “Lots of discussion about a U, L or V economic recovery. Why is no one talking about a K recovery? Some things will bounce back; some will not recover. Think about it.”1
As it turns out, this is effectively what has come to pass, no matter how simplistic single-letter analysis is. Technology, home improvement and online retail stocks have roared back since the lows, and their earnings and cash flows are higher than they were pre-COVID. These stocks are the up leg of the “K.” We are seeing records in lumber prices as new homes are being built and it feels like everyone is embarking on home improvement projects. Amazon and Wayfair and even Walmart are seeing incredible growth in deliveries as in-person retail struggles mightily. It feels like we are living our lives through Zoom, Webex and Microsoft Teams meetings online.
While stocks across all industries have predominantly moved up since the March lows, they have not recovered equally. Small companies, real estate, financials, energy, transportation, utilities and international and emerging stocks remain negative for the year. Energy companies are actually still down close to 50%.2 These stocks are the down leg of the “K.”
Concentration at the Top of the Market
The top four stocks in the S&P 500 Index (Apple, Amazon, Facebook and Microsoft) are up 51%, the other 496 are down (6.9%) year-to-date through September 30, 2020 (the S&P 500 is up 4.1% year-to-date through September 30, 2020). The graphic below represents the S&P 500. The horizontal size represents the stock’s year-to-date market capitalization growth. Green is new market capitalization created this year, while red is market capitalization lost this year. Taking out the dark-green stocks (Apple, Amazon, Facebook and Microsoft) results in the light-green shading being $0.5 trillion smaller than the red shading. The growth of these four stocks is greater than the combined growth of the rest of the S&P 500 stocks. In fact, if you take out just Amazon and Apple, all the remaining stocks in the S&P 500 would have combined for a negative return through the first three quarters of the year.
The top 10 stocks now make up 30% of the entire U.S. market, which is not unprecedented, but we have not seen this level of concentration since the tech bubble in the late 1990s, and before that back in the Nifty Fifty era around 1970. It is worth noting that after those two periods, the largest U.S. stocks struggled, and portfolios that had diversification both globally and domestically to small and value stocks benefitted significantly at that point.
When we talk to clients in deeply affected industries like the airline or restaurant industry, the general feeling is that habits have changed. Even with a vaccine or other universal treatment tomorrow, the current feeling is that it could still take years for those industries to return to pre-COVID levels.
Yet, within these hard-hit sectors, the stocks of those companies may very well deliver higher returns in the future. That is because stock returns reward companies that exceed expectations, and if they recover faster than expected, that will result in higher stock returns. This is true at the top of the market as well. To extend their extraordinary stock returns, the top companies will need to deliver even better results than people expect.
So we remain optimistic about the future across all asset
classes. Why? Because investing and financial planning at its core is an act of
optimism. We believe that companies that are currently struggling will find
ways to compete or change business models to adapt. We believe in our ability
as humans to adapt, change and continue to build for an unknown future.
Investing in and owning stocks is investing in human ingenuity in the
form of companies and believing that these companies will create value over
The path forward does not appear to be easy or straightforward, and there is a long way to go before we get to a point that we may consider normal. Based on history, there will be new winners and new habits after this pandemic has passed. Even if this recovery remains K-shaped in markets and in the economy, history would tell us that our approach toward financial planning and investing must remain disciplined and diversified. By maintaining a long-term plan and process, individuals will ensure that they benefit from the future, no matter what it looks like.
1 Ivan the KTM, “Lots of Discussion About a U, L or V Economic Recovery.” Twitter, April 17, 2020.
2 “S&P 500 Energy.” S&P Dow Jones Indices. Accessed October 7, 2020.
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