Published March 12, 2021
Below is the most recent analysis from Schwab’s Liz Ann Sonders. While some have struggled with the seeming disconnect between the stock market and economy over the past year, Ms. Sonders outlines how the market and economy have been much more in sync than we might realize.
“Before getting to the many unique characteristics of the COVID-19 cycle, an important reminder to investors is that stocks tend to lead the economy. In fact, the S&P 500® index is one of the 10 components of The Conference Board’s Leading Economic Index (LEI). The LEI is only 1.5% below its prior peak from July 2019 and has erased nearly 90% of its pandemic-related decline. Since last April, the LEI has surged nearly 14%, which is only the second time since 1959 that the nine-month rate of change exceeded 10%.
Because stocks tend to lead the economy, it’s typically the case that at major stock market inflection points, the economic data is typically lagging. In other words, market peaks have generally preceded recessions’ starts, and market troughs have generally preceded economic recoveries’ starts.
As the table below shows, in the post-WWII era, there was only one exception to bear markets starting and ending before recessions started and ended, respectively. Although the 2000-2002 bear market started before the 2001 recession began, the bear market continued for another 11 months after the short/mild 2001 recession had ended.
Bear markets have tended to start and end before recessions have started and ended
Source: Charles Schwab, Bloomberg, National Bureau of Economic Research. A bear market is defined as a 20% or greater drop in the S&P 500. Recession start and end dates are as determined by the National Bureau of Economic Research (NBER) Business Cycle Dating Committee.
When comparing the appreciation in stocks to the appreciation of gross domestic product (GDP), we are indeed at extremes in terms of “disconnect.” The ratio of the two is often referred to as the “Buffett Indicator,” given Warren Buffett’s oft-expressed view that it’s his “favorite” valuation metric. As you can see below, the ratio has never been as high as it is at present—recently exceeding the prior peak in 2000. That said, the expected surge in real GDP this year will likely bring this back down to earth via an increase in the denominator.
The “Buffett Indicator” is at an all-time high
Source: Charles Schwab, Bloomberg, as of 9/30/2020.
It has been an extraordinary run for stocks since the short-lived COVID-19 bear market ended in March 2020. The chart below shows just how unique the past year has been. We looked at every S&P 500 decline of at least 25% from an all-time high since the mid-1950s, and then tracked the subsequent rebounds. Needless to say, this time, the stock market’s recovery has been exceptionally strong and quick.
The S&P 500 index has rebounded strongly from its March 2020 low
Source: Charles Schwab, Bloomberg, as of 3/5/2021. Data indexed to 100.
Here’s where we look under the hood. From the start of 2020 through the early part of September 2020, performance was heavily biased toward a very small subset of stocks. The so-called “big 5” are the largest five stocks by market capitalization in the S&P 500, and currently include Apple, Microsoft, Amazon, Google (Alphabet) and Facebook.
As of September 2, 2020, the big 5 accounted for nearly 25% of the S&P 500 (remember, it’s a cap-weighted index). Year-to-date through September 2, 2020, the big 5 were outperforming the other 495 stocks by a whopping 62 percentage points, as you can see in the chart below. On average at that point last year, the big 5 were up 65%, while the entire rest of the S&P 500 was up only 3% on average. At that time, it was also the case that nearly 40% of the S&P 500’s stocks were still in bear markets (down at least 20% from their 52-week highs). The moral of that story is that for the first five to six months of the market’s rebound, the market was characterized by a very small handful of COVID-19 “thrivers,” while the rest of the market remained in a beleaguered state. That was certainly reflective of the behavior of the economy at that time.
The big 5 outperformed the rest of the S&P 500 in 2020
Source: Charles Schwab, Bloomberg, as of 3/5/2021. Big 5 stocks include Apple, Microsoft, Amazon, Google (Alphabet) and Facebook.
The characteristics noted above can be further fleshed out by looking at two sets of stock market cohorts. The chart below shows the comparative performance of the so-called “COVID winners” and “COVID losers.” As you can see, it wasn’t until early November that the latter cohort began playing catch-up to the former cohort—timed, not coincidentally, with the initial positive news about COVID vaccine efficacy. The latest moves took the “losers” cohort to comfortably above the “winners” cohort.
“COVID losers” began to catch up in November 2020
Source: Charles Schwab, Bloomberg, as of 3/5/2021. Data indexed to 100 (base value=3/23/2020). COVID winners consist of the Communication Services, Consumer Discretionary and Information Technology sectors. COVID losers include the Energy, Financials and Industrials sectors.
The market can be sliced and diced another way, as well. The chart below shows two Goldman Sachs-created indexes: “stay at home” stocks (those that are seen as beneficiaries of consumers spending more time and money at home) and “re-opening” stocks (those likely to benefit from consumers spending less time/money at home). Again, the timing of the pickup in relative performance by the re-opening stocks was also pinned to early November; with the latest moves bringing the “re-opening” cohort comfortably above the “stay at home” cohort.
Re-opening stocks began to perform relatively better in November 2020
Source: Charles Schwab, Bloomberg, as of 3/5/2021. Data indexed to 100 (base value=3/23/2020). The GS stay at home basket consists of U.S.-listed equities that may benefit from consumers spending more time and money at home. The GS re-opening basket consists of U.S. listed equities that may benefit from consumers spending less time and money at home.
Throughout all the fits and starts of economic activity associated with the implications of the virus/pandemic, the market has also displayed a heightened level of sector rotation and volatility. This is another way to illustrate that there has been some connection between the stock market’s behavior and leadership shifts; and the economic volatility associated with the pandemic.
The table below is a “quilt” chart that ranks the S&P 500’s 11 sectors on a monthly basis. Even with a quick glance, you can see that sectors have been all over the page in terms of performance wins and losses. Take a look at the Energy sector as an example. Its one-year performance (far right column) remains near the bottom of the rankings, yet it was the best-performing sector in four months during that period. Technology was the best-performing sector for a lesser three months, yet it remains at the top of the one-year leaderboard.
Sector “winners” and “losers” have changed position frequently
Source: Charles Schwab, Bloomberg, as of 2/26/2021.
If we look at weekly performance, we see an even starker picture of sector volatility (again, associated with heightened economic volatility). In the chart below, the yellow dots represent the return for each sector since the March 23, 2020 low. The blue bars represent the number of weeks each sector was the top performer among all 11 sectors, while the green bars represent the number of weeks each sector was the worst performer among all 11 sectors. One standout is the Consumer Discretionary sector (which includes Amazon). The sector’s gain since the March 2020 low is near the top of the leaderboard, yet it was the worst performer during more weeks than it was the best performer. Consumer Staples has been the worst performer since the March 2020 low, yet there has been an equivalent number of weeks when it was the best or worst performer.
Weekly sector performance has been volatile
Source: Charles Schwab, Bloomberg, as of 3/5/2021.
In sum, looking under the hood of the stock market’s behavior over the past year shows a bit more of a connection than is generally perceived. That said, a lot of prospective good economic news is now priced into the market. Additional economic upside should be rewarded; however, there is also a risk of market weakness if the rosy outlook is less rosy.”
After three weeks of weak/flat trade, stocks appeared to resume their uptrend this week with several indexes hitting record levels. Markets kicked off the week with a continuation of the uptick in interest rates. The rise in rates has sent high-flying tech/consumer shares lower in recent weeks. Monday found the Nasdaq -2.5% lower on those rising rates while the broad market only slid -0.5%. A step back in rates Tuesday sent those same tech/consumer shares soaring +3.7%, the biggest one-day advance for the Nasdaq in months. Market concerns over rising inflation diminished Wednesday with a fresh inflation report showing only a modest increase. The broad stock market rose +0.6% on the news. Another +1% gain for stocks Thursday as the latest round of government stimulus was enacted. The move left the S&P 500 at a record high level. Interest rates resumed their upward move Friday with the 10-year Treasury yield leaping over 1.6% (the yield was only 1.0% at the beginning of February). As has been the case recently, the jump in yields sent tech/consumer stocks downward while the broad market held up. But the downdraft in the Nasdaq for this day was relatively modest given how sharply rates rose.
The Nasdaq (QQQ) bounced back +2.20% this week, though the index failed to recover its closely-watched 50-day moving average line. The S&P 500 (SPY) rose +2.72% to close the week at a record high. Smallcaps (IWM) resumed their leadership with a +7.29% lift to also reach record high level.
Warm wishes and until next week.