U.S. stocks have managed to post some impressive returns in 2021 with most indexes up double digits year-to-date through the end of July. But what segments of the market are driving those strong returns, and what can history tell us about the likelihood of these strong returns continuing? In this market update, we will examine both of those questions in further detail.
To understand what is happening under the market’s surface this year, let’s first review the three main levers investors can pull to determine the type of equity exposure they can have: large vs. small companies, domestic vs. international companies, and growth vs. value companies (think Tesla vs. Caterpillar for this last category). When FSA’s equity portfolios are invested, the investment management team examines these categories on a regular basis to ensure we are invested in the better performing segments of the market.
So far in 2021, there has been an epic battle for market leadership in each of these three categories. We started off the year with an environment where international stocks, small-cap stocks, and value stocks were all the better performers, a trend that began in the fall of last year. The chart below depicts the year-to-date performance of the S&P 500 growth components (the orange line) vs. the value components (the purple line):
However, in late spring of this year, we began to see a shift back towards larger, domestic growth companies, a theme that had been largely dominant since 2017 with the exception being the last several months. Since around Labor Day of last year, this group of large growth companies (such as Facebook, Apple, Nvidia, Microsoft, etc.) had underperformed the broader S&P 500 Index, giving smaller or more value-oriented names a chance to carry the markets higher. Now we are once again seeing this cohort of large growth companies begin to outperform the market.
As this has happened, we have begun to shift our positioning back into large growth stocks in the hopes that we can capitalize on a resurgence in this segment of the market after it had lagged the broader market for almost a year.
In addition to this rotation back into large growth stocks, we have also witnessed deteriorating market breadth. This is defined as the percent of stocks in an index that are participating in the index’s overall move higher. When only a handful of stocks are marching higher, breadth is low and serves as a potential warning sign for equity investors. One way to measure this is to look at the percent of stocks in the index that are above or below their respective average prices over the last fifty days. According to Ned Davis Research, the percent of S&P 500 components above their critical fifty-day moving averages has fallen from ninety percent at election time to around forty percent today (pictured below).
This is just one of many indicators that the FSA investment management team watches to determine how strong the stock market is. While deteriorating market breadth is not a reason alone to sell our equity positions, we will continue to monitor it closely.
So, how might equity markets perform going forward? While past performance is never a guarantee of future returns, we can at least look to history for some potential clues. The FSA investment management team looked back over the last four decades of S&P 500 return data and examined the performance of the index through the end of the year when it had been up as much as it is so far in 2021. The results reveal that the index went on to finish at a higher level in every year except 1987 when the infamous Black Monday stock market crash occurred. The results are depicted in the chart below with 2021 as the red line. From an historical perspective, it suggests that the positive trends we’ve seen so far could continue, although the pace of returns could slow.
Despite this positive historical tendency, we are currently in a seasonally weak period of the year with August and September returns historically being flat to negative, so it would not surprise us to see a pullback here. If so, the FSA Safety Nets® stand ready in the event of a selloff at any point in the remainder of the year. As always, please feel free to contact us with any questions or comments at questions@fsainvest.com.
Derek Kravitz
Investment Analyst
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