The third quarter of 2020 enjoyed a continuation of a rebound in stock prices around the world. Stocks marched upwards in July and August, before retreating in September. Still, returns for the quarter were solidly positive. The S&P 500 is now positive year-to-date, while most of our accounts are still modestly down, as both international value funds and small-cap value funds lagged.
The S&P 500, as noted, continued to lead the way, as it is dominated by large-cap growth stocks (more on this below). Strangely, this is in the face of an economy that is nowhere near recovering to pre-COVID levels. U.S. Gross Domestic Product (GDP) was down a staggering 31.4% in the 2nd quarter, is expected to rebound +/-20% in the third quarter, but still be down around 8% for the year. Not the economy you would expect to accompany a record stock market.
One explanation for this, in our view, is that support for the market has been bolstered by fiscal stimulus and monetary policy. With yields on Treasuries, CDs, and savings accounts at or near zero, there really is no alternative to stocks for investors seeking returns.
However, it is worth noting that under the surface, there are clear winners and losers, haves and have-nots, and the index returns mask a somewhat less rosy reality.
Even within the S&P 500 itself, the “average” stock is down for the year, and more than half the stocks within the index are down for the year. It just so happens that the stocks doing best are more heavily weighted within the index. The top 5 companies in the index are up around 30% year-to-date while the rest of the index is down 5%. This has pushed the weighting of the top 5 stocks to 22% of the index surpassing the 18% weighting the top 5 companies were of the index at the peak of the internet bubble in 2000.
Likewise, “style-box” analysis reveals a huge disparity between both large and small and growth and value, where large growth is up 24% and small value is down 22%, year-to-date. We’ve never seen disparities of that magnitude.
This phenomenon evidences itself within our actively-managed fund portfolios, where the gulf between our winners and losers is as wide as we can recall, with individual fund returns year-to-date ranging from +53% (Artisan Developing World) to -28% (Vulcan Value Partners Small Cap). Those two, neither of which are widely represented across client accounts, are the extremes, but even amongst our more widely held positions, there were winners (Akre Focus Fund, Sequoia Fund) and losers (Oakmark International, Dodge & Cox International). Rest assured, we regularly take long and critical looks at those that are persisting struggling against their benchmarks.
While our exposure to international, small caps and value stocks in general has cost us some relative performance, we stand by the principals of diversification in an effort to spread risk, to prepare for a wide range of unknown future outcomes, rather than predict those outcomes and wager accordingly. Likewise, we are frequently asked about what the outcome of the November election might mean for markets. Again, we think our actively managed and diversified portfolios are well-suited to perform in an uncertain environment.
One bright spot for us has been our internally managed individual stock portfolios, which were up around 6% year-to-date, on average. We have gained some confidence around our ability to deliver this service, and welcome inquiries from those of you not currently participating.
In a final note, we just completed the sale of Tim Medley’s remaining firm ownership to the three of us, and he is now fully retired from his transitional role with the firm. We appreciate his mentorship and guidance over the years, are grateful for the opportunity to continue the legacy of excellence he established and are energized and excited to build upon that legacy going forward.
*Source: J.P. Morgan Asset Management Guide to the Markets