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The Market Looks Toward a Post-COVID Economy

By nearly every measure, 2020 was an unprecedented year. In our Q1 2020 letter from mid‐April, we noted that over 1.9 million people had been infected with COVID‐19 globally with over 127,000 deaths. As of February 3, 2021, over 100 million cases have been reported and more than 2 million have died. In the U.S. alone there have been over 26 million reported cases and over 450,000 deaths – far and away the global leader in both categories. We all know families who have been touched by this crisis, and our thoughts are with everyone who has been affected. With the prospect of mass vaccinations around the corner, and the number of daily infections beginning to drop, our hope is that we begin to turn the corner in the coming months. In the meantime, we encourage everyone to continue to stay vigilant and safe.


In this letter, we review some economic and market trends of 2020 and examine if they hold hints of what’s to come in the year ahead.

Figure 1: U.S. unemployment stands at 6.7% after peaking at nearly 15% in April 2020. Source: Fortune.

Wall Street vs Main Street. It is a well-worn phrase that “the stock market is not the economy” and 2020 was a stark illustration of this. In addition to the large number of infections and deaths due to the pandemic, the economic toll of coronavirus has been severe. The U.S. unemployment rate hit nearly 15% in April 2020 (the highest since 1939), ending the year at 6.7%, nearly double the rate at the beginning of the year (see Figure 1). The Congressional Budget Office predicts that the number of employed Americans will not return to pre-pandemic levels until 2024. Much of the job loss can be attributed to the shuttering of small businesses – Oxxford Information Technology estimates that approximately 4 million U.S. businesses closed in 2020, including many small businesses where the impact of the economic shutdown was too great to bear.

Figure 2: U.S. GDP fell 3.5% in 2020, the largest drop since the end of WWII. Source: CNBC.

Measured by gross domestic product (“GDP”), the U.S. economy has been on a wild ride over the past year. GDP shrank by 31.4% in the second quarter of 2020 (the largest quarterly economic contraction since the Great Depression), only to rebound in the third quarter, gaining 33.4%. Still, while GDP rose another 4% in the fourth quarter, that was not enough to net annualized growth, with the economy shrinking 3.5% in 2020 (see Figure 2).


The stock market, on the other hand, saw incredible growth and resilience in 2020 even in the face of the pandemic. The steepest bear market in history, with the S&P 500 Index falling over 33% from February 19 to March 23, also turned out to be the third shortest – about five months later, the S&P 500 Index (along with many other major market indices) fully recovered its losses. Despite notable volatility in the second half of 2020, markets ended the year at record highs, with the S&P 500 Index rising approximately 70% since its March low to finish up over 18%.

Figure 3: The “FAANG+M” stocks all outperformed the S&P 500 Index in 2020 and thus, were significant contributors to the S&P 500’s positive return. Data Source: Portfolio Visualizer.

“Stay-at-home” stocks dominated. In fact, all major global indices were positive in 2020, but the tech-heavy NASDAQ index, posting a +43% return, led the charge. Investors, spurred by fiscal stimulus and historically low interest rates, poured money into companies that stood to benefit from the shift towards at-home consumption. As an example, the so-called “FAANG+M” stocks (Facebook, Apple, Amazon, Netflix, Google/Alphabet and Microsoft) rebounded from their March lows in an extraordinary fashion, outpacing the S&P 500 for the year (see Figure 3). In fact, just three large tech companies – Microsoft, Amazon, and Apple – accounted for over half of the return of the S&P 500 in 2020.


As regular readers of our quarterly letters know, while the pandemic exacerbated the phenomenon, the dominance of the S&P 500 by a handful of tech behemoths predates 2020. Our second-quarter letter from 2018 examined the concentration of the FAANGs in the S&P 500 – because the S&P 500 is market-cap weighted, the largest companies in the index contribute more to the index’s overall return. Back in June 2018, the FAANG+M stocks accounted for approximately 14% of the weight of the S&P 500. As of December 31, 2020, those same six companies now account for nearly 24% of the index. In fact, the weight of the 10 largest stocks in the S&P 500 has been steadily increasing since 2014, only falling off a record high in the last few months of 2020 (see Figure 4).

Figure 4: The weight of the top 10 stocks in the S&P 500 has been increasing over the past five years. Source: JPMorgan.

Signs of a broadening market? This recent decrease in the concentration of the top 10 stocks in the S&P 500 coincided with a rotation away from the “growthy” FAANGs and towards value stocks and cheaper sectors. Value indices outperformed growth indices in the fourth quarter across all geographies and market cap segments. While this may be short-lived, there are some reasons to suggest otherwise. For one, as demonstrated by the disparity between stock market highs and the less rosy economic health of the country, the stock market is forward-looking – investors may be signaling that the sectors and companies that are historically cheap (travel-related businesses, energy, banks, traditional retail, etc.) will rebound as vaccines are rolled out and people are eager to leave their homes again.

Figure 5: The weights of the stocks in the market-cap weighted S&P 500 Index (in blue) are concentrated in the largest companies while they are evenly distributed in the equal-weighted index. Source: S&P Dow Jones Indices.

We also see evidence that the market is not just shifting from growth to value stocks, but also to smaller companies beyond the mega-cap FAANGs. This is well-illustrated by examining the performance of equal-weighted indices. As mentioned above, major market indices are typically market-cap weighted – as the market capitalization of each company in the index rises and falls, so does its overall weight in the index. In this way, the largest companies in the index contribute the most to the return of the index. In contrast, the weights of stocks within an equal-weighted index do not change over time. Instead, each stock is held at the same weight, with the index rebalanced (typically quarterly) to ensure all index constituents have equal influence on the overall performance of the index (See Figure 5). In this way, the smallest companies in the index contribute as much to performance as the largest.


As you would expect, because just a handful of the largest companies in the index have been the best performers, the market-cap weighted S&P 500 has outperformed the equal-weighted index over the past decade. However, over the longer term, the equal-weighted S&P 500 has actually outperformed the market-cap weighted index (by nearly 200 basis points annualized over 20 years, for example), suggesting that a market dominated by just a few massive winners is not the norm and is likely unsustainable. In fact, charting the relative cumulative outperformance of the equal-weighted S&P 500 against the market-cap weighted index over time, and comparing it to the concentration of the top five names in the market-cap weighted index shows this dynamic at play – as market concentration falls, the equal-weighted index outperforms the market-cap weighted index (see Figure 6). This was the case in the fourth quarter of 2020, with the equal-weighted S&P 500 outperforming the market-cap weighted index by over 600 basis points. Other major market indices performed similarly – for example, the equal-weighted MSCI All Country World Index also outperformed its market-cap weighted counterpart in the fourth quarter. Investor flows into equal-weighted ETFs have greatly increased beginning in the last few months of 2020, a trend that has continued into 2021 – another sign that perhaps the market expects a post-COVID recovery to benefit smaller cap companies in neglected sectors more than the already pricy FAANGs.