This year, 2020, has been an interesting year to say the least. Financial markets have experienced the quickest drop from all-time highs to bear market losses of 20% or more with the S&P 500 Index losing -33.94% in just three weeks. The market decline was followed by a head-spinning rally that lifted the index back to even within a couple of months. While the ever popular FANG stocks made it back to even and posted new all-time highs, most stocks are still down for the year. In recent months, tech stocks have continued to rally while other stocks have been resigned to eat dust.
The large-capitalization FANG stocks have exclusively powered the S&P 500 to positive returns so far this year. What most investors don’t realize is the “market” is actually down for the year. As of September 25, 2020, the New York Stock Exchange FANG+ Index is up an eye-popping 67% (see Chart 1). The index represents a more concentrated segment (10 stocks) of the technology and consumer discretionary sectors consisting of the highly-traded growth stocks such as Facebook, Apple, Amazon, Netflix, and Google. These same companies account for 43% (including Microsoft) of the NASDAQ Composite Index weight and nearly a quarter of the weight for the S&P 500 Index.
Chart 1: Tech stocks push S&P 500 Index to positive returns, other stocks experience large losses in 2020
Other stocks have not fared as well this year. For example, the largest 30 stocks in the United States are down nearly -5% and the smaller companies of the Russell 2000 are down almost -12%. The New York Stock Exchange Composite Index, which represents all of the stocks not listed on the NASDAQ, is down -10% this year. The index includes small, mid, and large companies as well as international American depositary receipts (ADRs). Dividend-paying stocks have been battered in 2020 with the S&P 500 High Dividend Index down a whopping -30%. This same theme has persisted over the last few years as well (see Chart 2).
Chart 2: Value stocks underperformed tech stocks for last few years
It seems like we have heard this story before. In 1999, a retired widow visited the office of a financial advisor that I know. Her well diversified portfolio had been trailing “the market” (a.k.a. the S&P 500 Index) and she felt like she was missing out on the attractive returns being chatted about by her friends. Specifically, she couldn’t understand why everyone was talking about “Yoo-hoo”. Yes, that Yoo-hoo. And, she wanted to move all her money into that one stock. She did not realize her friends were actually talking about the internet stock Yahoo. Investors tend to succumb to the hype when markets are in a speculative frenzy.
The Fed’s easy monetary policy and stimulus have helped keep stock prices buoyant since the Financial Crisis. Anemic economic growth over the past 10 years has contributed to the underperformance of value stocks, dividend payers, and smaller companies while favoring large tech stocks. The capitalization weight effect of the largest handful of tech stocks have helped to keep index returns superficially strong. We have seen this theme play out before during the “Tech Bubble” of the late 1990s (see Chart 3). If you remember, the Fed also reduced rates back then to keep the good times rolling.
Chart 3: During the “tech bubble” value stocks underperformed tech stocks for many years
So, what happens next? I am not going to say that this is “Tech Bubble 2” and that the bubble is inevitably going to burst. It certainly could. However, with the Fed keeping rates low and Fed stimulus on top of more Federal Government stimulus, I think the economy could not only recover, but could start to grow at a much faster rate than expected. Strong economic growth and a recovery in corporate fundamentals are what we need to set the market up for an extended bull market run.
If you have read Don Schreiber, Jr.’s book All About Dividend Investing, then the last 20 years would be characterized as a classic underperformance market cycle with the S&P 500 Index averaging 6% (or far less than) the historical average return of almost 10%. The latest bear market in 2020 could be the end of this underperformance cycle.
Surely, technology (just as it was in the 1990s) is changing the way we live our lives. For that reason, tech stocks will likely have good performance in the years to come. At the conclusion of the 1990’s outperformance trend, tech stocks outperformed dramatically as they became wildly overvalued just before the “bubble burst”. However, undervalued dividend paying and small and mid-cap (SMID) stocks will likely lead again just as they did after the tech stocks crashed in the early 2000s, dragging the tech-heavy NASDAQ Index down by close to 80%. From 2000 to 2017, the performance of the S&P 500 High Dividend Index trounced the performance of the NASDAQ (see Chart 4).
Chart 4: Is a rotation to value-oriented stocks on the horizon? Value outperforms tech for extended periods
With stimulus, low rates, and an infrastructure spend on the horizon, these stocks are likely to experience a similar strong resurgence. And, with Baby Boomers retiring en masse over the next decade, dividend-paying stocks may have an additional tailwind as Boomers search for yield and inflation protection. With the economy compromised by COVID-19 related shutdowns, a pandemic that could worsen, geo-political risks rising, and a presidential election that could further destabilize America, seeking safety in dividend-paying stocks would seem to be the way to go. After all, many successful investors tend to follow Warren Buffet’s value-oriented mantra of “buy low and sell high”.
Matt Schreiber is CEO of Award Nominated WealthTech Platform investwithcy.com, Co-CEO & Chief Investment Strategist of WBI, Podcast host of Bull | Bear Radio, and alum of the University of South Carolina.
Photo by Marta Branco from Pexels
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“FANG” stocks: the stocks of four popular technology companies: Facebook, Amazon, Netflix, and Alphabet
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