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Beneath the Equities Rally’s Hood
A cursory glance at major global equity indices shows a pretty clear V-shaped recovery—with a total return of 1.6% in the S&P 500® Index from February 19, 2020 through October 26 and similar pictures in the Russell 2000 and the MSCI ACWI ex US Indices. So are stocks just invincible? Or considering the available economic data, nascent spikes in COVID cases in Europe, and historically poor corporate earnings, is the market too optimistic? Breaking down the broad indices provides some interesting insights for both the bull and the bear cases.
The S&P 500® Index’s top 10 performers, which include the FAANG stocks along with a few other strong names, have been the real dynamos. On their own, the 10 stocks would have pushed the index up 8.3%, but the tepid performance among the other constituents has tempered the index’s overall performance since February. Because of the outperformance of these names, the collective index weight of those 10 constituents also has increased, going from 18% on February 19 to 24% by October 26.
Similar trends hold in the Russell 2000® and the MSCI ACWI ex US Indices. The latter’s top 10 names by performance have lifted the index’s total return 3.5% and collective weighting to 10.9% of the index. While less pronounced than the S&P 500, the impact of top performers on these indices’ performances is notable since they have broader market coverage with many more constituents.
A potential upshot of greater index concentration is a self-reinforcing cycle of top-performing names’ increasing influence on the overall index performance—the better they perform compared to the rest, the more they affect the index’s total return. This dynamic may be more significant in the S&P 500® Index given the smaller number of constituents and how large a collective weighting the top-10 performers have already achieved. Consider: Among the Russell 2000® Index’s top-10 performers, most rose more than 100% between February and October, but their collective weight only went from 1% to more than 3% over the same period
So, what’s happening among all those other stocks? In the S&P 500® Index, more than 40% of its constituents remain more than 10% below February 19 levels, while more than 50% of the Russell 2000® Index’s and 40% of the MSCI ACWI ex US Index’s constituents are still down more than 10%.
Based on headline index performances, a case could be made that the US market has overcooked. Similar cases could be made across non-US markets, where forward PEs of major global indices are running well ahead of their 20-year medians. But beneath the surface in all these markets, conditions would seem to suggest some runway remains for large swaths of stocks that have yet to recover.
Looking forward, there are a few possible outcomes. On one hand, stumbles among a few index leaders could create the appearance of the bottom dropping out of the market. On the other, there seems ample room for the market to continue running if some of the weaker-performing names to date turn around in the period ahead. Either way you slice it, it would certainly seem to be a prime stock-picking environment.
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