Sunday, December 06, 2020

Broadening Equity Market Participation

It seems a broad range of equity indices are hitting new all time highs every day and some investors question whether this can continue. The S&P 500 Index closed at an all time high Friday, December 6, bringing its year to date return to 14.5% on a price only basis. In earlier posts I discussed the roller coaster ride of the market as it traversed the coronavirus shutdown and reopening. The S&P 500 Index fell 33.9% from February to March and has bounced higher by 65.3% from the March 23 low. And since the election in early November, the S&P 500 Index is up 12.5% with only one of the five weeks down a fractional .76%.

As investors review the market strength, a common refrain has been noting the narrow leadership, i.e., the basket of FAANG+M stocks or mega cap stocks. Clearly these mega cap equities were an early driver of the market's advance, but now a broader set of equities is participating in the market's move higher. As the below chart of various asset classes shows, since the beginning of September, the mega caps are the weakest performing segment. At the top of the performance list is U.S. small company stocks, followed by midcap and emerging market equities.

This broadening participation is healthy for the market and can lead to further highs as investors rotate into these other asset classes. This is clearly seen by looking at just the S&P 500 Index too. Since early September the equal weighted S&P 500 Index, represented by the green line in the below chart is up 12.0% and is outperforming the cap weighted S&P 500 Index, up just 3.8%. Even the once lagging dividend payers are performing well, up 9.7%. One can read more on the dividend payers in my October post, Dividend Paying Strategies Have Lagged This Year, Now An Opportunity?

Serving as a tailwind to the market's strength is the improving economic picture, not only in the U.S, but globally as well. Of course the economic improvement continues to be partially supported by government stimulus programs around the globe, but nonetheless the data is improving. As the below Citigroup Economic Surprise Indices for various regions shows, surprises remain positive, i.e., above zero.

The market will not move higher in a straight line. Coming out of recessions though, as corporate earnings growth resumes and the economic data improves, the market's path of least resistance is higher.

The market technical data does trade at elevated levels too, but can do so for an extended period of time. As an example, the percentage of S&P 500 stocks trading above their 200 day moving average is 91%, a high level. As the below chart shows though, this high level can be sustained for an extended period of time.

An additional view of the market and the 200 day moving average is shown in the below chart. The current price of the S&P 500 Index is 17% above its 200-day moving average. Clearly this is a high level; however, coming out of recessions (grey shaded bars), this is not uncommon.

Investors will see and experience equity market pullbacks, a normal function of markets. There also remain issues on the horizon that can trip up stocks, like the Georgia runoff election on January 5, which will determine control of the Senate and Congress. The outcome will likely impact tax policies and thus have an impact on corporate earnings. The roll out of a Covid-19 vaccine will have some impact on the market as well, along with other known and unknown issues. At this point in time though, with an improving economy and earnings picture and continued low interest rates, stocks want to move higher, but investors should expect pullbacks.

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