The Story of Two Different Market Environments

CAMS Weekly View from the Corner – Week ending 5/8/2020

May 11, 2020

When it comes to the stock market, it is more than knowing if a particular well recognized index is continuing to trend in its established direction, be it up or down.  Rather, one general observation point to make is whether the broad market is acting well or if strength is coming more sporadically via pockets of strength.

One of the most well recognized stock market indices is the S&P 500 Index.  This is comprised of 500 companies and is meant to give a sense of a broader market than say the Dow Jones Industrial Average which is made up of 30 companies.

The often cited S&P 500 Index though is a weighted index which means the components of said index play a larger or smaller role on the index results according to the percentage weight they carry in the index construction.

While this gives a good sense of the broad stock market there is also an S&P 500 index that is equal weighted.  This means all 500 companies have the same impact on the results of the index performance.

With this the equal weighted index gives us a truer sense of how the broader stock market is performing being all 500 companies’ impact the results the same.

To place our current developing market environment in context let’s first look at the relationship of the S&P 500 weighted and equal weighted indices for the full year of 2019.

SPY - 5.11.20
Click for Larger View: https://stockcharts.com/h-perf/ui?s=SPY&compare=RSP&id=p34618249783

The black line is the weighted version and the blue line is the equal weighted version of the S&P 500 for full year 2019.

The key observation here is to notice how the two tracked one another closely.  With this we can see the broad stock market was acting well.  In fact, in the early part of 2019 the equal weighted index was actually outperforming the weighted version of the S&P 500.  Through it all there was usually a 2% differential between them and at times nearly 0% differential.

Below we are sharing the same chart only it identifies the relationship of the two thus far in 2020.

SPY - 5.11.20 2
Click for Larger View: https://stockcharts.com/h-perf/ui?s=SPY&compare=RSP&id=p39373383807

In the front part of 2020 the relationship remained as had been the case in 2019.  This represented an overall strong market whereby most sectors, sub-industries and stocks were performing.  Interestingly, even in the cliff-dive portion of 2020 we saw the relationship hold whereby the two remained relatively close in performance.

This has changed notably since mid-March when the market reversed its cliff-dive and began moving upward.  Since then the two have trended together but the performance difference remains quite obvious.  Currently, the difference between the weighted and the equal weighted index is 7 ½%.

This informs us that we have been under a “pockets of strength” recovery which can also be called a more recognized label of a stock pickers market.

The significance of this is the masses have become quite accustomed, in the previous several years, to owning an overall stock market investment and enjoying out-sized returns.

If the above relationships continue it will be offering a stock pickers market environment and with this the masses may be confused as to what happened to their broad based market investment and its out-sized returns.

More simply, with these developing relationship trends, a more concentrated investment strategy may be needed to provide positive returns relative to expectations meeting previous performance experiences of recent years.

It remains early in this process but evidence continues to build that the new market environment we are heading into will be a more concentrated market and with this the proverbial “stock pickers market” will be bandied about.

I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Portfolio Manager, CAMS Spectrum Portfolio

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP).  This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”.  A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.