Are we headed for a Double-Dip in the Stock Market?

The US stock market is yet to re-test its late March lows, even though background challenges remain. UK investors should therefore remain vigilant. From an economic perspective, the deterioration continues. More than 26 million Americans filed for unemployment over the five weeks running up to the end of April. The coronavirus spread may be peaking in some parts of the US, but it remains a major impediment to normalisation across most states. We are seeing similar uncertainty in the UK and the rest of Europe. The search for treatments that work against COVID-19 continues. The failure in a Chinese trial of Gilead Science’s much-heralded Remdesivir drug, for example, disappointed investors. Then there have been the more obscure suggestions offered up, that may indicate just how far away we may be from a solution. Falling into that camp was President Trump’s proposal that injected disinfectant might be used as a remedy. In addition, the US results season that has started to reflect the large-scale demand destruction and lack of earnings visibility. Blue-chip companies have been withdrawing guidance amid the uncertainty of how the coronavirus and shutdowns are impacting their business. And, of course, it would be amiss to not mention the extreme volatility that has come with the oil price collapse. So, what’s prevented the stock market from going into freefall? One dynamic supporting the broader market has been the performance of the technology sector, and, in particular, a narrow band of names. The five largest stocks in the S&P 500, Microsoft, Amazon, Apple, Google and Facebook, collectively represent a higher percentage of the market than any other five stocks since the late 1970s. Combined, these names account for over 21% of the S&P 500’s market capitalisation. As a result, they have had a major distorting effect on how the market performs.                  Those same five largest stocks have as big a weighting in the S&P 500 as the bottom 350 stocks in the index. So, while the rest of the market has crumbled at times, these big-cap names have continued to march on. Microsoft alone represents ~5.5% of the index, higher than its peak weighting during the dotcom bubble.  

The Largest Stock in the S&P 500 

      

The scale of such market distortions is rare. As such, there would be an argument for UK investors to look to switch out of such high-flyers and rebalance into areas of the market that have lagged. But betting against technology stocks has been a losing trade for years now. Investors have been focused on secular growth stories that make sense beyond an economic cycle. That’s why stocks exposed to the cloud, digital transformation and next-wave technology themes have remained popular. At some point you would think this train has to slow down. Betting on this one space can’t go on forever. But at the moment, the lockdown environment and “work from home” theme, which rely on online platforms and digitalisation for people to remain engaged and productive, continues to drive an investment bias towards these names. The online world has never looked more attractive. The thinking is that large technology stocks can still grow their earnings in this context and are less sensitive to economic contractions. That’s why smaller stocks and cyclical names have been under immense pressure. For example, the pain that retail companies are experiencing is being reflected in their stocks. Nordstrom and The Gap are both down 60%, Macy’s and Bed & Bath are both down 70%. They have far more risk to their earnings currently. At the same time, with billions of dollars in cash on their balance sheets, investors are flocking to these technology names during this difficult period. Quite simply, investors believe these stocks are a safer bet right now. This train of thought is particularly relevant when factoring in the massive monetary and fiscal stimulus working in the background. This has given investors more confidence when deciding on where to put their money to work. The winners are being separated from the losers. Time will tell whether this should be a period for more caution.

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