Explaining the 2020 Stock Market

Understanding the U.S. stock market in 2020 is fairly easy — the bigger, more expensive companies are performing better than the smaller less expensive companies. That’s it.

There are 505 companies in the S&P 500 with a combined market cap of roughly $29 trillion. As of Monday around noon est, the index is down 0.7% for the year. Considering the market was down 34% at the lows in March, this is a decent place to be.

But the performance of the individual components of the market is all over the map and the borders for that map can be drawn neatly by company size. Here’s a look at the S&P 500 broken down by market cap showing the median size, price-to-earnings, prices-to-sales, price-to-cash flow, price-to-book value and year-to-date returns as of the close on Friday:

There is a clear pattern at work here. The biggest companies by market cap are the most expensive by traditional valuation metrics and they also have the best returns this year.

The smallest companies by market cap are the least expensive by traditional valuation metrics and they also have the worst returns this year.

The market doesn’t always line up so perfectly by size but this year’s performance attribution is crystal clear.

Considering the median stock in the index is down 11% on the year, the fact that the market is more or less flat can be explained exclusively by the biggest companies holding the highest weights in the S&P. The top 50 (and really the top 10) stocks have more than made up for the larger median losses in the rest of the market.

There are two ways to look at this data:

(1) The S&P 500 is so top-heavy that once these stocks falter, look out below.

(2) This is the nature of a market-cap weighted index where the winners carry the day without having to pick them in advance.

In a recent outlook piece, Morgan Stanley shared a graph that perfectly illustrates the beauty of an indexed approach to investing:

Cyclical stocks had their day in the 1940s, 1950s and early 1980s but the market is now dominated by growth, stability and defense stocks. Cyclicals are now at their lowest weighting in the index on record.

If you invested in a simple S&P 500 index fund you didn’t have to predict this sea change in advance. You didn’t have to make a bet on certain stocks, industries or sectors. The winner-takes-all nature of the S&P 500 itself did this for you.

The same is true of the larger stocks outperforming in 2020. There were no tilts involved to benefit from these moves. No research or financial statement analysis or reading through quarterly earnings transcripts. The market does all that for you.

Market cap weighted investing is far from perfect and doesn’t diversify investors from every risk out there. But it remains one of the hardest investment strategies to beat because of its very nature.

Index funds are nothing special. They’re simply low-cost, low-turnover, tax-efficient and rules-based.

The market remains very hard to beat.

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.