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Through the Bulk of Earnings

August 10, 2020
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In our last blog we noted that the market seemed to be in a state of contradiction because technical indicators were hinting at higher price action while fundamental earnings were an ominous question mark.  Now that we are through earnings season the market has had time to digest more information from companies hinting at their potentials for future growth. 

What we have seen thus far is pockets of the economy showing great prospects for growth.  While cloud computing, cloud data storage, and data encryption/protection are industries that have been profitable now for several years, the digital shift towards work from home, school from home, everything remote has accelerated significantly due to Covid19. The growth numbers in streaming alone have been staggering.  Companies who have prioritized these segments of their businesses showed significant growth in their business models. Even companies who were once considered consumer product companies that have shifted their business models to integrate with the cloud or a subscription service have proven resilient. On the flip side brick and mortar storefronts, swipe based transactions, banks, and industrial companies who’s business models are less dynamic online have seen abysmal growth. 

Now, what does this mean for the markets? 

(First of all, I think reiterating what we mean by the markets might help add context.  The market in our terms is the S&P 500 which is the largest 500 market cap weighted companies in the US. An important thing to note is that this index is weighted.  This means that the larger companies or mega-cap companies will carry the index more than a smaller companies. So, the largest cap company in the US - Apple carries 6.7% of the indices weight. This means Apple can greatly dictate the entire index just by its price action alone. The top 10 weighted companies control about 28% of the SP500.)

Because the market is weighted by this definition, and only pockets of growth have been evident since Covid19, we have seen a decoupling in the top 10 market cap companies vs the remaining 490.  In fact 2 of these 10 companies accounted for 15% of the SP500’s 2019 returns.  Basically, if you haven’t had the majority of your portfolio in the top 10 weighted companies, you have probably underperformed the market over the last several years. 

We believe this increases the risk of owning S&P 500 funds or etf’s as the index is inflated by a few companies.  If a few of these take a nice downturn, it could easily correct the entire market.

Since the onset of Covid19, we have seen continued unemployment claims go from 1.7m (March 20th) to 16.15m as of July 11th.  In addition, we have seen the market come back to within 1% of All-time highs.  While it seems you cannot sit completely on the sidelines in this market, we’d be extremely cautious adding aimlessly to equities at this point.  We’d focus on industries that are resilient in the midst of economic stagnation like health care, cloud companies (because of covid19), streaming/gaming, and subscription based companies who have continued growth numbers.  

In addition to the inflated market, we have a new ‘heating up’ of sorts in relations between the US and China.  While we are not in a full out trade war like we were in 2019, it seems the war is shifting towards a tech management / intellectual privacy war.  President Trump last week signed some executive action against Chinese investment company Tencent. If there is one thing we learned about the last time China and the US were in dispute, it is that the market reacts poorly to these headlines.  

All of these facts are taking place during an election year, where generally the market chops around sideways until after November.  So, we remain diligent, cautious, and quick to apply the brakes in 2020 as we feel protecting what you have should take precedence over pursuing massive gains from these market levels.