Are stock markets really performing well?
These days, we’re all looking at the great performance of stock markets, as evidenced by the S&P 500 index in the U.S. and the S&P/TSX in Canada, which have gone up at a tremendous rate since the March 23 pandemic low. I thought it would be interesting to put some of this into perspective for you, the investor, as many of you are wondering why your investment portfolios aren’t keeping up to the market indices.
The key issue is that indexes are constructed based on the market value of companies – thus, the larger a company is the more effect it has on overall market performance. Let’s start with the S&P 500, a popular benchmark for U.S. Stock Investors. This index comprises of the 500 largest publicly-traded companies in the U.S. The following table shows the composition of the five largest companies in the S&P 500 Index:
The top five companies represent 1% of the total companies on the index, but account for 25% of the index value and, basically, account for that proportion of the index performance. In fact, the five companies account for 10.74% of the S&P 500 YTD performance. So, the remaining 495 stocks were actually down 6.25% YTD.
Some additional points to consider:
- If you equal weight all the stocks in the S&P 500 index, the index performance would be -3.5%
- Only one third of stocks in the index are positive YTD
- I’ve shown the revenue growth of the companies – I’ll let you judge whether these companies have gotten ahead of themselves
- When we compare the technology-heavy NASDAQ Index performance to the broader market S&P 500 performance, we haven’t seen a disparity like this since 1999 – we all know what happened after that bubble burst
The key point I would like to make is that although these are great companies, few, if any, portfolio managers are going to invest 25% of your U.S. Equity portfolio in just five companies. Generally, their portfolios are more broadly diversified across the many sectors in the market. Although this may have led to more recent underperformance, an element of risk has been taken off the table by virtue of the portfolios not being heavily laden in just a few high-performing technology companies.
And now for some further insight on performance challenges in the Canadian Equity market. Similar to the U.S., Canadian Equity managers have had a difficult time outperforming the market over the past couple of years, and particularly this year. The biggest story in our market has been Shopify. We’ve all heard about Shopify surpassing the Royal Bank to become the largest stock on the S&P/TSX Index. Shopify now amounts to 7% of the total Canadian Stock market in terms of value. This has also had an effect on overall performance of the Canadian Market as follows:
Source: Yahoo Finance
The table above illustrates how much of an effect the performance of Shopify has had on the overall index. The remaining 299 companies on the index had a significantly lower return than the index.
Canadian Equity managers have been further challenged by the rally in gold stocks due to the significant gold price appreciation, combined with the downfall of energy stocks due to the precipitous decline in oil prices as a result of the COVID 19 pandemic. Any Canadian Equity manager would be challenged to outperform the market without a significant weight in Shopify and Gold, or with a market weight in energy stocks.
The following table compares the Royal Bank and Shopify as of August 17th:
Source: Yahoo Finance
When equity managers analyze stocks, they’re looking at a combination of fundamental characteristics of companies which include earnings growth combined with valuation measures in determination of a sound investment. Clearly, Royal Bank, along with many other fundamentally sound companies, has been “ignored, under-loved and underappreciated” by stock investors so far this year, and even stretching back into last year. Investing is a patience game, and managers with patience will eventually see their portfolios rewarded over time as things normalize. We can’t really say when that will happen, but the past has shown that strong companies eventually reward patient investors. So before you question the sanity of your portfolio manager who’s sticking with the Royal Bank-like companies, take a step back, be patient and trust them to know how to invest your assets prudently.
Steven Belchetz, SVP Business Development & Client Relationships
CWB Private Investment Counsel