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Podcast #3: Economic Reality and the Stock Market

May 14, 2020

Listen below for this week’s Financial Connections update.

 

Script

Hi Everyone,                                                                          

In a previous communication, I mentioned that the economy and stock market are not synonymous. The evidence is quite extreme at this point.

The economic reality seems increasingly disconnected from the stock market. First quarter corporate earnings reports showed significant declines and the Second Quarter is expected to be worse. Yet the stock market continues to rise. In fact, the S&P 500 had its best month in 33 years.

Added to this backdrop is the increasing unemployment rate which will go higher than the current 14+%.  Of the unemployed, almost 40% are in the leisure and hospitality industry. Financial services industry has the lowest unemployment, around 5%.

The stock market has always been referred to as a leading economic indicator – meaning it anticipates where it believes corporate earnings and the economy will go. While the market is still down in what would be called a correction as opposed to a bear market (recall 20% or over is a bear market) it seems optimistic to assume the economy is going to bounce back quickly.

I would like to believe the economy and therefore employment will return quickly. But I also think we should also be prepared for Round 2 of the virus. Epidemiologist consensus is that this virus is not ready to recede.

The S&P 500 is frequently referred to as representative of the economy with broad diversification. However, there are times when a few stocks are so large they swing the index whether it is going up or down.

Let’s define what the S&P 500 is. It is an index of 500 large companies selected by a committee. It is called a market-weighted index. It is calculated by taking the share price times the number of shares the company has outstanding. That number equals the percentage within the 500 companies.

 It might surprise you to know that of the 500 companies in the index, almost 20% is made up of 5 stocks. If you buy $100 in the S&P 500 index, $20 is going to 5 stocks. Most of us would consider this concentrated, not diversified.

The 5 stocks are: Apple, Microsoft, Amazon, Alphabet (Google) and Facebook. The last time there was such a concentration of technology stocks was 2000 – just before the dot.com bubble. These 5 stocks are up for the year but the other 495 stocks are down over 13% at the end of April.

One of the reasons our investment committee decided we would emphasize fund managers that select companies they feel will grow in the future as opposed to emphasizing index funds is this type of concentration doesn’t help diversify portfolios but increases the risk within the portfolio.

If we combine the concern for the economy with a potential of Round 2 of the virus and the concentration of 5 stocks comprising 20% of the S&P 500, you can understand why we feel managers who can say yes or no to buying a stock could help dilute this concentration and select companies that will grow in the post-pandemic world.

Each podcast I try to find some good news. This is the podcast version of the mood buster we include in our emails.

Kroger, the grocery store chain, has what they call a Dairy Rescue Program. It takes donated excess milk previously sold to restaurants or hotels and pays to process and re-package it. The milk goes to food banks.

It was a banner month for renewable energy. Beginning March 25 through the end of April, solar, wind and hydropower generated more electricity than coal.

Finally, Lowe’s partnered with local nurseries to deliver over $1 million worth of flowers to mother’s in senior homes that restrict visitors. The flowers were delivered by Uber.

Please stay safe. We look forward to the time we can greet you face to face.

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