To say the markets have been volatile is an understatement! The first quarter of the year was one of the worst quarters ever, and it was followed by one of the best quarters ever. So what changed? Well, everything and nothing. If you looked at your portfolios on January 1st and then again on June 30th, you’d have seen a very moderate decrease, which in the investment world is basically a non-event. However, if you looked at your portfolio more frequently, such as every month/day/quarter, then you would have had to take anxiety medication. The moral of the story is: Don’t look at your portfolio as often; focus on the longer term.
Obviously, we have been fielding a lot of questions about the markets and what will happen next. Of course, no one has a crystal ball; however, as we noted in our article a few weeks back Climate Versus The Weather, stock prices are based on future company profits and earnings rather than on current earnings. That’s why we saw such a large recovery in the second quarter. That, coupled with a mind-numbing amount of money from the Federal Reserve and stimulus from the CARES Act, has put the markets about where they were this time last year, which is pretty amazing when you think about it.
However, there is more to this story. The most recent rally, as well as those that occurred in the past few years (specifically in the US), have not been broad-based, which means that only a few stocks and one industry have carried the market forward. Those stocks are known as the FAAANM stocks, which stands for Facebook, Apple, Alphabet (Google’s parent company), Amazon, Netflix and Microsoft. These few stocks (and some other tech stocks) now account for more than 50% of the value of the US stock market. That means seven stocks out of 3,000 are worth more than half the entire market. The top two, Apple and Microsoft, are now worth 50% more than the Russell 2000 index (small company stocks), and they are worth more than the entire Chinese stock market! The chart below shows the impact of these seven stocks on the US market in the past five years. One million dollars invested in those seven stocks grew to $4.5M. Without those seven stocks, the S&P 500 would be close to flat.
So what do these numbers mean? Well, from an investment perspective, it makes no sense to put all your money in just seven stocks—that goes against the sage advice to never put all your eggs in one basket. Secondly, the valuations of these stocks are multiple folds higher than the rest of the market. Part of this phenomenon is simply that investors buy the stocks that have made money in the past, driving these stock prices higher. Of course they are great companies, but the price one pays for them is exorbitant; therefore, this trend won’t continue. Also, when your handyman and Uber driver are day-trading these stocks, it may be time to trim your positions.
We’ve seen this sort of concentration before. It happened from 1994-2000 during the tech bubble. We now know it was a bubble, but at that time no one believed it. From 2000 until 2010, a full decade later, those stocks were behind virtually every asset class out there. To this point, when we look at the performance of these concentrated positions going forward, we see they tend to underperform after such a run–up. The chart below shows the underperformance over periods of time.
Bottom line: You should own these companies, and of course we already have 10-15% of your stock allocation in growth/tech stocks. However, you shouldn’t have all your hard-earned money in just seven stocks, or just one industry. The name of the game here is “diversify,” and for those who missed the recent rally with cash on hand, know that many parts of the market are still compelling and well-priced for investment.
As you may have noticed on our website, we are also now providing a very in-depth market analysis for the quarter. Please click here for the second quarter analysis. https://bluerockwealth.com/q2-2020-bluerock-quarterly-market-review/
As always, we welcome your questions and thank you for your trust and patience.
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