I want to follow-up on last month’s article by digging a little deeper into the move in the S&P 500 so far in 2020 and what the implications could mean for future investments. The idea for this issue was sparked by a McKinsey article where they explore the divergence seen in different sectors of the market.
A common narrative we hear today is that returns for the S&P 500 have been driven by a handful of Tech companies. YTD performance for some of those stocks are truly amazing. As of 7/22/20, Amazon (+67%), Apple (+32%), Facebook (+17%), Google (+17%), Microsoft (+34%), Netflix (+51%).
When I saw this chart I thought seven months is too short of a time frame to draw any substantial conclusions. I figured if we looked over a longer time frame returns by sector would be more balanced. The recent spike in Tech would be an anomaly and other sectors would have performed well. I was wrong. Very wrong.
Over the last 5.5 years only two sectors have outperformed the S&P 500 (+75%)! Technology (+181%) and Consumer Discretionary (104%). I should have remembered my April 2019 newsletter where I looked at how the composition of the S&P 500 has changed over the last thirty years. Tech went from ~6.0% of the market in 1990 to ~26.0% as of 4/30/20. As Marc Andreessen famously predicted, software is eating the world.
Just because the last five-plus years has been driven by Tech, doesn’t mean the next five will be the same. As we think about the impact COVID-19 has had AND will continue to have on the economy, however, it is obvious to see why certain companies and industries benefit. Here is a quote from Microsoft CEO, Satya Nadella, “As COVID-19 impacts every aspect of our work and life, we have seen 2 years worth of digital transformation in 2 months”. COVID-19 is acting as an accelerant for trends already taking place, which disproportionately benefits the Tech sector.
At this point, it is important to remember everyone’s favorite financial advisor truism, “Past returns are not indicative of future results”. The market is already making a judgement on who is the winner and loser from COVID-19. By and large it is a continuation of the last five years. Anything related to Technology, Software, E-commerce, the Gig Economy, and Cloud Computing are winning. Legacy businesses relying on physical assets and locations are losing.
Can such a dichotomy exist in perpetuity? Probably not. Investing axioms like this tend to be taken to extremes. We both over and under extrapolate the impact from today’s events. Supporting today’s valuations is each company’s financial future. I am not implying we are in a bubble. Instead, the point I am trying to make is not all Tech stocks are great. And not all non-Tech stocks are bad. Today’s market and narrative obfuscate this point.
This is a good thing for me. As an “active” investor, I look for investments that I believe can compound returns at a double-digit rate over a five to seven year horizon. As investors clamor for a certain type of investment, I am finding opportunities in areas overlooked by the market. Hopefully this translates into double-digit returns with little correlation to the broader market. Considering the S&P 500’s dependence on the Tech sector, now might represent a good time to consider investing a portion of your portfolio in a strategy like mine.