McCarthy & Cox News and Articles
2020 | A Look Back and Forward
Wes Bean, Director of Investment Services
As 2020 began, the US and China were making progress towards settling their trade dispute, tensions continued with Iran, brushfires continued to spread in Australia, and WHO reported on social media there was a small cluster of pneumonia cases in Wuhan, China. By the end of January, an impeachment trial had started, Brexit1 was over, and we had our first case of “pneumonia” here in the US. While this would be enough to fill an entire “normal” year, 2020 has proven to be anything but normal.
By March, these “pneumonia” cases that began in Wuhan had spread globally and become known as Covid-19. That led to stock markets entering the fastest bear market in history, followed by one of the fastest recoveries in history.
On top of Covid-19, the US has had its own wildfires out west, a star went missing2, Kim Jong Un may have passed, the Pentagon released footage of UFOs3, we’ve had widespread social unrest, murder hornets have appeared, and we’ve resorted to using the Greek alphabet to keep track of Hurricanes.
So, as we approach year end (whew) and continue to grapple with Covid-19, we hope most of the year’s events are behind us, and we can return to some semblance of normal.
Oh wait – there’s an election? So much for less excitement…
All kidding aside, we fully expect volatility to remain elevated throughout the remainder of the year. In our view, investors are best suited to continue doing what we’ve always maintained - manage risk by forming and adhering to long-term strategic asset allocations, and then making small, tactical shifts as opportunities arise.
That said, what follows are some thoughts on the markets, what impact the election may have, the Federal Reserve’s actions, and what we’ll continue to do to at McCarthy & Cox to navigate the remainder of 2020.
The S&P 494
A full recovery from the March lows in the S&P 500 is not indicative of what’s really going on in the market. Through the end of August, the S&P 500 was up nearly 7.5% YTD, and 56% from its March lows. Yet looking at individual company performance, nearly 60% of the 500 companies are in the red this year, and 40% are down more than 10%. So how is the average up when most companies are down? The answer lies in how the index is constructed.
The S&P 500 is a market cap weighted index, meaning the companies that make up the index are weighted according to the total market value of their outstanding shares. Components with a higher market cap carry a higher weighting percentage in the index. As a result, large movements in stock prices for the largest companies significantly impact the value of the overall index.
You’ve likely heard of the FANG, FAAMNG, or FAANG stocks (Facebook, Apple, Netflix, Amazon, Microsoft, and Alphabet/Google) and how they’ve contributed to the market’s return. You might not know to what extent though. These six names make up 25% of the S&P 500’s market cap. To understand the impact they have, through August, they returned on average 40%. If the rest of the S&P 500, let’s call it the S&P 494, had returned zero, the overall index’s return would still be north of 10%.
Another way to see the outsized effect of large companies is to look at the performance of an equal-weighted index. In this index, every company carries the same weight, so the return is simply the average performance of each company in the index. The return through the end of August was -4%. Interestingly enough, the S&P 494’s return would have stood at -4.4%...
The stock market versus the economy
“The performance of stock markets, especially in the United States, during the coronavirus pandemic seems to defy logic,” notes Nobel Prize-winning economist Robert Shiller. “With cratering demand dragging down investment and employment, what could possibly be keeping share prices afloat?”4
The most common explanation for this seeming discrepancy is that “the economy is not the market.” But while this is easy to say, it can be hard to understand. Let’s look a little deeper.
US GDP includes a much broader range of economic activity than that associated with the stock market. The US economy, as measured by gross domestic product (GDP), differs from the US stock market. It reflects a much broader range of economic activity that includes personal consumption, government spending, and imported and exported goods and services. By contrast, the stock market reflects only the activity of public companies, and investors’ reactions to that information.
In addition, GDP captures activity from both public and private companies. This includes companies of all sizes – all the way from Walmart and Amazon to your local pizza shop. While there are about 4,000 publicly listed companies on US stock exchanges, there are more than 5 million employer-owned businesses of all sizes across the US.
The largest companies dominate stock market performance, further skewing comparisons with the broader economy. Not only is there a disparity when comparing publicly traded companies to the economy, that gap becomes even wider when you consider that a few large public companies dominate the stock market. We previously discussed the FANG/FAAMNG/FAANG stocks, and how much their performance contributes to market returns. Taking it further and looking at sales, the 10 largest companies by sales in the S&P 500 account for $2.7 trillion, or 22%, of all public company revenue. And if we expand that to the top 50 companies, it’s $6.8 trillion, or 55%, of all revenue for public companies.
Also, of note: the top three sectors in the S&P 500 Index are technology, healthcare, and communication services - sectors which may actually benefit from the current environment. These sectors represent just over half of the market value of the S&P 500. So, in the current crisis, the divergence between the economy and the market may be even more exaggerated.
Most people in the US are not employed at companies that trade in the US stock market. Prior to the impact from Covid-19, there were about 160 million people employed in the US. About 40 million worked for publicly traded US firms5. But even this isn’t straightforward. Many American companies employ people outside the US. Walmart is the largest US employer with 2.2 million workers, but only two-thirds of them work in the United States. So again, the diversified economy that employs about 160 million people is very different from the stock market of publicly traded companies that employs roughly 25% of American workers.
The stock market is a leading indicator. A leading indicator shows improvement before the actual economy does. Stock prices are forward-looking in the sense that investors buy and sell stocks not based on what happened yesterday or what is happening today, but rather based on their expectations for the future. Think about a company that has an impressive earnings report for its most recent quarter but warns about the coming quarter. The stock will most certainly sell off. In this case, the stock valuation reflects the future, not the past. There will always be discrepancies between the current economic environment and how investors value companies over the coming years.
Elections matter, just not in all the ways you might think to an investor. Of course, they hold great importance in upholding the US tradition of democratic, representative government. However, historically speaking, elections have made essentially no difference when it comes to long-term investment returns.
Investors may be inclined to sit on the sidelines during election years out of fear and uncertainty. That’s rarely a winning strategy. While its true markets have been more volatile during primary season, they’ve tended to rise strongly thereafter. History shows that markets have risen whether a Republican or Democrat has been in office.
The only thing we can say conclusively about the market data is that prior to an election, markets tend to trade sideways, but with higher volatility. After the election, the market has consistently delivered stronger returns.
Elections will generate headlines, but don’t be thrown off course. It’s understandable to have concerns, but if history is any guide, in addition to the winning candidate, the real winners will be the investors who avoid the temptation to base their decisions around election results, and stayed invested for the long haul. Besides, didn’t we all know Hillary was winning the 2016 election?
The Federal Reserve
Last week, the Fed promised to hold its policy rate close to 0% until inflation is on track to “moderately exceed” the central bank’s 2% target “for some time.” They noted they didn’t see inflation hitting 2% until 2023, which implies they won’t increase their policy rate until at least then.
They also note, “…over coming months we will continue to increase our holdings of Treasury securities and agency mortgage-backed securities…” So, while the scale of the Fed’s monetary stimulus dwarfs its response during the Financial Crisis, it appears it will continue for some time. With all this liquidity, we should get used to a low-yielding environment for a prolonged period.
Their most recent statement was intentionally vague as the Fed is trying to be cautious, but it seemed to leave the markets with more questions than answers.
1. Brexit is the withdrawal of the United Kingdom (UK) from the European Union (EU).
4. https://www.marketwatch.com/story/robert-shiller-explains-the-pandemic-stock-market-and-why-its-decoupled-from-the-economy-2020-07-07?mod=article_inline The Russell 3000 index is used as a proxy for the market. The Russell 3000 includes the 3,000 largest US-traded stocks, which collectively account for roughly 98% of all US incorporated equities.
Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged, and investors cannot invest directly into an index. Market references refer to the S&P 500 Index, a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. Fixed Income or Bond market references refer to the Barclays Capital Aggregate Bond Index. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Commonwealth Financial Network does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.
What Does the Coronavirus Mean for Investors?
Presented by McCarthy & Cox
Despite attempts by Chinese authorities to contain the coronavirus, the numbers make clear that the virus is now spreading around the world. According to the World Health Organization, there are 79,331 confirmed cases, of which 77,262 are in China and 2,069 are outside of China (as of February 24, 2020). Unfortunately, the numbers only seem to be growing, with the Washington Post recently reporting that there were 833 confirmed cases in South Korea and 53 confirmed cases in the U.S.
Investors Expect More Bad News
Indeed, the markets have taken notice. As of this writing, global financial markets are down by 3 percent or more. Here in the U.S., they are down by almost 5 percent from their peaks. This drop is one of the largest in recent months, and it reflects the sudden apparent surge in coronavirus cases. Investors are clearly expecting more bad news—and rather than wait for it, they are selling.
Is selling the right thing to do? Probably not. The virus could continue to spread and even get worse. But we do know a couple of things.
Putting the Risk in Context
First, new cases in China seem to be leveling off, having peaked between January 23 and February 2. We can expect things to get worse in countries with new outbreaks, but steps can be taken to help control the virus—as has been shown in the origin country.
Second, countries have been applying the lessons learned from China, which should help contain their outbreaks. For example, the Centers for Disease Control and Prevention (CDC) reports 14 cases diagnosed in the U.S., as well as 39 cases in people repatriated here from China or the Diamond Princess cruise ship. Cases here appear well contained and under surveillance, which should help limit any spread. The same holds true in most of the developed countries.
For all the hype, then, in many countries and certainly in the U.S., the coronavirus remains a very minor risk. Another way to put that risk in context is that during the current influenza season, there have been 15 million cases, 140,000 hospitalizations, and 8,200 deaths. Compared with the average flu season, then, the coronavirus does not even register. With 53 current coronavirus cases, it could certainly get worse. At least in the U.S., however, the overall damage is not likely to come close to what we already accept as “normal.”
Signs of a Slowdown in China
While the risk to your health may be small, that may not be the case for your investments. The epidemic has already caused real economic damage in China, and it is likely to keep doing so for at least the first half of the year. The same case seems likely for South Korea. These two countries are key manufacturing hubs. Any slowdown there could easily migrate to other countries through component shortages, crippling supply chains around the world. Again, there are signs in the electronics and auto industries that the slowdown is already happening, which will be a drag on growth. This risk is largely behind the recent pullback in global markets.
Here, the key will be whether the disease is contained—which would still be a shock to the system but would be normalized fairly quickly—or whether it continues to spread. Right now, based on Chinese data, the first scenario looks more likely. If so, Chinese production should recover in the next six months, with the economic effects passing even more quickly. It might help to think of this situation like a hurricane, where there is significant damage that passes quickly. Stock markets, which typically react quickly on the downside, can bounce back equally quickly. Should the virus be contained, it would be a mistake to react to the current headlines. We have seen this situation before—the drop and bounce back—with other recent geopolitical events.
Can U.S. Ride Out the Storm?
Even if the virus continues to spread around the world, those in the U.S. should take a deep breath. The U.S. economy and stock markets are among the least exposed to the rest of the world, and they are the best positioned to ride out any storm. Further, the U.S. health care system is among the best in the world, and the CDC is the top health protection agency in the world. As such, we are and should be relatively well protected. Finally, given that the U.S. economy and markets depend primarily on U.S. workers and their spending, we are less vulnerable to an epidemic. We should do relatively well, as has happened in the past.
Stay the Course
The headlines are scary and recent market declines even more so. But the economic foundation remains reasonably solid around the world. The epidemic is a shock, but it is not likely to derail the recovery. The World Health Organization, while recognizing the risks, has not declared a pandemic, indicating that the risks remain contained. The U.S. is well positioned, both for the virus and for the economic effects.
We certainly need to pay attention. But as of now, watchful waiting continues to be the proper course.
McCarthy & Cox Retirement & Estate Specialists LLC is located at 127 W 5th Street, Marysville, OH 43040 and can be reached at 937-644-0351 Security and advisory services offered through Commonwealth Financial Network, member FINRA, SIPC. A registered investment adviser.
Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, at Commonwealth Financial Network®.
© 2020 Commonwealth Financial Network®
Press Release | August 31, 2020
McCarthy & Cox Charity Outing a Success
Held on August 20, 2020, the 8th annual McCarthy & Cox Charity Golf Outing was a huge success. Although COVID-19 brought about some changes for the event this year the weather for the event was beautiful. Through many generous donors, this year’s outing raised a record-breaking $22,965 for two charities; The McCarthy & Cox Cares Fund and The Elizavèta Fund, both of which are housed at the Union County Foundation.
The McCarthy & Cox Cares Fund was founded in 2013 by Tom McCarthy & Jim Cox to assist seniors, youth, and emergency needs in Union County. To date, the Fund has donated more than $43,000 in the community. The Cares Board consists of five current McCarthy & Cox clients who independently review grant requests from the community. For more information, visit McCarthyandCoxCares.com.
The Elizavèta Fund was founded in 2014 by Jim and Faye Cox to help families with the financial burden of adoption costs. Jim & Faye adopted their daughter, Caroline Elizavèta, from Russia back in 2011. Throughout that process, they came to realize the financial and time commitment that adoption requires and decided to seize the opportunity to help others with the undertaking. Over the years, the Elizavèta Fund has granted over $65,000 to assist 16 families, aiding in the adoption of 17 children - with at least two more on the way. For more information, visit ElizavetaFund.org.