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Market Snapshot

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LIZ ANN SONDERS:  Hi, everybody. Welcome to the October Market Snapshot.

What I would like to do today is take a little bit of a look under the hood of what’s been happening in the stock market, important in the context of what the headlines often say, which is just about the resilience of the market. And I’ll explain in a minute why I just put air quotes on the market. But I want to look at some of the underlying leadership shifts, and churn, and activity under the surface that I think puts a little more color on what has already been a very unique year in terms of market performance, behavior of the economy, etc.

So let’s just start by looking at some simple statistics here. This looks at the three, or three of the most primary common benchmark indexes for the US equity market. You’ve got the S&P 500, the NASDAQ, and then the Russell 2000 Index of Small-Cap Stocks. And here are just their year-to-date returns for each of those indexes. You see the S&P has performed best, up 16%. a little bit less for the NASDAQ and the Russell. And then we start to get into some of the more interesting stuff. So you’ve got the percentage of members of each of those indexes that have a positive year-to-date return, and they’re pretty lofty numbers, certainly for the S&P 500, at 81%. But, unfortunately, the analysis often stops there, and the conclusion is, ‘Boy, it’s been an incredibly strong market. It’s been a resilient market.’ But a look under the surface reveals something a little more stark, and this goes to that point about what’s actually happening in terms of churn and leadership shifts under the surface.

So take a look at these last two columns. We’re still looking at the same indexes here, but that third column there now looks at the percentage of the members of each of these indexes that have had at some point this year at least a 10% correction, often called a drawdown, from whatever the year-to-date high is. And these are probably surprisingly lofty numbers—91% for the S&P, 98% for the Russell 2000, meaning, going back to the S&P, 91% of the S&P’s members have had at least a 10% correction at some point this year. And if you look at all of the stocks in each of these indexes, that last column shows what the decline, on average, has been for those drawdowns. So you’re looking at minus18% in the case of the S&P 500. I’ll remind you that 20% down constitutes in a bear market. You’re looking at much more significant declines, on average, for the NASDAQ and the Russell. And this just points to this churn that’s been under the surface.

The reason why the indexes have been more resilient is because when you’ve had these rotations where you get pockets of weakness in certain segments of each of these indexes, you have corresponding pockets of strength. And that’s netted out to limited downside for the indexes overall, even though the weakness you have seen under the surface is more extreme. So I want to go down a little bit deeper and look at some of the sector-based changes that have occurred this year.

So I’m going to start here with a chart that just goes back to the beginning of the bull market, so the March 23rd, 2020 low, when we started this new bull market. We’re 18 months or so into that. And those yellow dots, where the axis is over on the right, shows the performance of each sector during that period of time, and it’s ranked left to right, best to worse. So you can see the energy sector has been the best performer since the low in the market of March of 2020, and utilities has been the worst performer. But we need to, again, look under the hood a little bit more, and we can look at the percent of time that each sector was in a leadership position for a particular week on a rolling basis.

So you can see, maybe not surprising, that the energy sector has been at the top of the leaderboard during the highest number of weeks. That would be consistent with having the best performance. But you’ve also had a sector like financials that is the second best performer, yet has had a fraction of weeks where it has sat atop the leaderboard. We can also look at the number of weeks where each sector was at the bottom of the leaderboard, was the worst performer. And here you see for a sector like energy again, best performer, but it’s had almost the same number of weeks where it’s been at the bottom of the leaderboard as the top, highlighting just how dramatic these swings have been. And, in fact, across these 11 sectors, six of them have the green bar higher than the blue bar, which means they’ve spent more time at the bottom of the leaderboard than they did at the top of the leaderboard.

Let’s look at it more on a monthly basis, and just take another sort of visual look into what’s been going on under the surface. A visual like this may look familiar to a lot of people, not just because I’ve shown it before but it’s a fairly common way to look at performance either on a month to month basis or a year to year basis. Typically, it’s a year to year basis and each color represents a broad asset class. But we decided to take a different approach here and look at sectors instead of broad asset classes. So this is all 11 sectors in the S&P 500, plus the S&P 500, itself. And it’s ranked in each column based on best performer/worst performer. And it’s on a monthly basis, so you’ve got 12 months of data here. On the far right you can see the one year, that full period, what the ranking is. And energy for the last year, in addition to the last 18 months or so has been the best performer. And you can see utilities is at the bottom.

But here’s what we’re going to have a little fun with this page. So we look at this and say, ‘Oh, all I needed to do was be in the energy sector in the past year and I would have done extraordinarily well.’ The rub is would you have been able to handle the swings? And that is the story we’re now going to show, because if you simply focus, as an example, on the energy sector, it has moved dramatically. It is often gone from very bottom to the very top, maybe just off the top, back to the top, all the way back down to the bottom, all the way back up to close to the top, vice versa, all the way back to the bottom, and back to the top. So it’s the swings that are important to look at, to get a sense of just how much volatility there is and has been that gets you to the point where energy is the best performer. And you would think, then, a sector like utilities, which is on the bottom of the performance ranking, it doesn’t tend to be the big winner in most markets, it tends to be a bit more stable and defensive, but we can also look at the pattern for a sector like that at the opposite end of the spectrum in terms of the past year. Again, you see these huge swings even for a classically defensive sector like utilities.

So it just highlights how dramatic the underlying movements have been. And I think that there are a lot of reasons behind this and lots of forces that have driven some of these leadership shifts. The nature of COVID, itself, the incidents of cases, the move up and down in bond yields, the recent uptick in inflation data, concerns about growth in the context of higher inflation, all of these have been forces that have defined these shifts that have happened in terms of leadership.

We can also look at it in a different way. We’re still sort of telling the same story here, but this looks at sector leadership by taking vertical bars here, each one, again, color-coded and you can just see, it almost looks like, you know, a Missoni pattern here, with how shifty the colors are. It’s just another way to visually look that over this time where the S&P, the black line, has been, you know, with some volatility, but steadily rising. The shifts under the surface have been much more extreme.

Now we’re going to move back up a notch and look at broad breadth, because what breadth does is not only helps us to get a sense of leadership, but it also looks at whether there’s underlying weakness that might be masked by indexes that continue to do well at what I would call the headline level.

So here are two ways to look at breadth, and they both involve moving averages. So it’s about looking at the percentage of stocks in each of these three indexes, same indexes we’ve shown before, what percentage of stocks are trading above key moving averages. So the top chart is the 50-day moving average. The bottom chart is the 200-day moving average. And one way to think about this is what is typically the case is if you’ve got an index at a high or near a high, but a lot of the underlying components, the underlying stocks are weakening, one of the analogies that’s often used is if you have the generals at the frontline in a battle, but the soldiers are falling behind, you’re in a weaker position than if the generals and the soldiers are all at the front line. And you can see a bit of that, in particular, looking at the top chart.

So you see toward the right-hand side of that top chart, a point where the S&P 500 had more than 90% of its stocks trading above their 50-day moving average, so that’s the blue line. But there was a big gap that had opened up because the NASDAQ and the Russell 2000 broader indexes with more stocks were in a steadily deteriorating mode. Then you saw the three kind of converge all move down together until the latter part of the summer. You saw another kind of divergence back up with the S&P doing better, and then, more recently, you’ve had not only the NASDAQ and the Russell kind of play catch up, they’re now sitting in better positions. So some of that underlying churn has actually given a lift to stocks in the NASDAQ, to smaller cap stocks that had been left a bit more behind back in the spring period of time. That’s actually a better environment than what we did have in the spring.

And then if you look relative to 200-day moving averages, that’s shown below. And the real message here is really since the spring of this year, you’ve been, although choppy, in a fairly steady descending sort of environment in terms of participation, the percentage of stocks doing well relative to moving averages. And that’s some weakness under the surface that I think does reflect a lot of the risks with which the market is contending lately.

You can also look back to the sector level at breadth by sector. So this combines what we showed on the prior page by looking at stocks relative to the 50-day moving average, stocks relative to the 200-day moving average, but breaks it out by sector. So you can see, in keeping with energy having been the best performing sector over the past year, over the past 18 months, at present, 100% of stocks in the energy sector are trading above both their 50-day moving averages and 200-day moving averages. That reflects the extraordinary recent momentum. The rub there, of course, is you mathematically can’t go higher than 100%. You might stay at 100% for an extended period of time, but, clearly, any movement off 100% can only go in one direction and that’s down. So just be mindful of that if you’ve been sort of playing the momentum in what has been the recently best performing sector.

Conversely, a sector like utilities, actually, recently, had 0% of its members trading above their 50-day moving average. We’re now up to 11%, but much like was the case when you’re with any sector at 100%, if you hit 0%, mathematically, you can’t go below 0%. So the path of least resistance at some point starts to go up. So keep that in mind, especially if you’re a stock picker and you want to be careful about not chasing momentum to a point where certain stocks or sectors become a significantly outsized portion of the portfolio.

And then you can look at the differences among the other sectors. But I wanted to focus on those two outliers, importantly, and just highlighted via those.

The real net of all of this is in this environment of heightened volatility broadly, much more volatility under the surface, leadership shifts that have had myriad drivers over time, the key to success is not trying to anticipate those shifts in advance, you will drive yourself crazy trying to do that, but apply a lot of the tried and true disciplines that sometimes are boring to talk about, but really become important in a market environment like this. So diversification across asset classes, within asset classes, periodic rebalancing, stay in gear, take advantage of the swings by adding into weakness, trimming into strength, that’s the best way to stay in gear without trying to forecast.

And then if you are a stock picker, the one factor that has been a really consistent outperformer, regardless of whether it’s within the energy sector, or the utility sector, or the technology sector are factors around quality. You want to focus on quality, reasonable valuations, but good growth prospects, strong balance sheets, and I think at this point in the cycle, especially with the added volatility, you want to make sure you’re focused very much on quality. And I think that will be an additional defender against some of this volatility.

So thanks, as always, for listening.

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