31 Aug 2020
The number of times we have seen journalists and economists try to extrapolate data to determine which letter of the alphabet typifies the shape of the recovery over the last few months has multiplied as the economy has changed. We started with a V shaped recovery, moved to a U, then a Nike swoosh and the latest is a K shaped recovery with many variations in between. With hindsight we will no doubt be able to apply a letter at some point, but in a period when the value of Apple shares has shot to over $2 Tn and the Berkshire Hathaway holding is on its own worth 123 bn dollars, we do need to take note of where the recovery is taking place and the inequality it is creating.
Warren Buffet started buying Apple shares in 2016 and amassed $35 billion dollars’ worth. The value of that on August 25th, 2020 was as noted above, $123 billion - a profit of 88 billion dollars - not bad for a four-year investment! This example helps to illustrate the very narrow focus of the market over the last 18 months. Technology shares have ballooned in value in the US and the so termed FAANG stocks such as Facebook, Alphabet and Amazon have led the way.
The US stock market has hit new highs in recent weeks, propelled by several of the largest companies identified above in the tech space, but also by companies that have benefitted from Covid-19 such as pizza makers Dominos and soap manufacturers Colgate Palmolive and Unilever. The majority of stocks are still down though - share process of a fifth of the S&P 500 companies are more than 50% below their all-time highs as of the 21st of August 2020. The average stock is 28% below its peak.
The concern of course is that such valuations in large companies, which drag the index up, cover the reality of what’s going on in much of the economy. This has promoted the K shaped theory of the recovery where there was a sharp fall followed by a big divide in fortunes. Only three sectors have outpaced the S&P 500 this year. Unsurprisingly, technology was one, with the other main sector being consumer discretionary, but this has been dominated by the rise of Amazon which accounts for 43% of the consumer discretionary index.
This probably highlights more than anything else the vulnerability of the market recovery as any negativity surrounding the tech giants could bring markets crashing back down. The saving grace is that strong earnings do support most of these companies, it’s not a repeat of the late 1990’s tech bubble when valuations were built on unrealistic earnings forecasts. This effect has also led to those stocks known as growth stocks being more highly valued than so termed value stocks. The S&P 500 growth index is up 11% while its value counterpart is down 13%. Is growth in a bubble? The jury is out right now but the gap has opened up significantly and doesn’t look like closing anytime soon. The most recent Fed announcement, that they are prepared to let inflation creep ahead of targets, does give some optimism for value stocks such as banks, but isn’t the only shift that needs to happen to bring the returns of the two styles closer together.
There will no doubt be other selections from the alphabet to describe the recovery process over the coming months as the economic backdrop changes. A working vaccine will make a huge difference to confidence, but a post Covid-19 world will not operate in the same way and there will be winners and losers. This is currently obvious in valuations leading to very varied sectoral outcomes, the haves and the have nots, as they could be described. We should be mindful that positive market movements can still mask the struggles in the underlying economy.
Ken Rayner, Director, RSMR
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