Looking Beneath the Surface of the Current Equity Rally

08.20.2020 - Ronald J. Sanchez, CFA

Key Takeaways
  • A handful of stocks have driven S&P 500 Index returns this year.
  • Investors unsurprisingly prefer best-in-class companies in today’s climate.
  • Broad participation in the rally remains largely absent.

Who could have imagined back in March, as equity markets were plunging, that a rapid and strong recovery was about to unfold? Similarly, who would have thought that by August the S&P 500 Index would not only be in positive territory for the year but actually establish an all-time high? 

What a difference in five months. The movement in equity prices during such a brief period is nearly as unimaginable as the pandemic itself. It begs the question: how is it possible that markets have seemingly returned to a pre-COVID-19 level while many aspects of the world we live in are so distinctly different? On the surface, stock markets in the US have roared back due to three significant developments:

  1. Evidence emerged that efforts to flatten the virus curve were successful, coupled with a growing confidence that second-wave outbreaks would not lead to widespread shutdowns.
  2. The combined government response provided a source of stability and funding that reassured nervous investors and granted temporary relief to the recently unemployed.
  3. The economy rebounded, with worst-case scenarios avoided.

Unquestionably, these three factors have broadly supported a market recovery. However, the reality is that there’s likely a long road ahead before the world returns to its pre-COVID-19 environment. Restaurants have been operating at minimal capacity, airlines struggle to fill planes, and office buildings remain empty. How do we make sense of a socially distanced world that has seemingly pushed the S&P 500 Index to all-time highs?  

Equity performance seen through a different lens

Looking below the surface to better understand the drivers of market performance, we deconstructed the S&P 500 Index. What we found was that after removing the “best-in-class”, biggest companies, the index’s return profile looked substantially different. Essentially, a few of the largest stocks have thrived during the shelter-in-place climate, owing to their dominant global presences, impressive digital platforms and strong balance sheets. In looking at the S&P 500 in two different ways, with their largest members removed and also equal weighting each stock, we found that the index’s return profile has continued to be dominated by the few, not the many.  

The S&P 500 has returned 2.4% year to date1, an impressive accomplishment considering the continued economic challenges and uncertainty associated with the impact of the virus … more than 10% unemployment with many local businesses closing their doors, perhaps forever. However, it’s important to note, the S&P 500 is not a reflection of local businesses but rather the largest multinational companies in the world.

As the chart below shows, the five largest stocks, representing about 22% of the S&P 500, have propelled the broader index higher. Five years ago, this same group represented only 10% of the Index. Their doubling in size has only magnified the impact of these five firms. For instance, Apple’s market cap ($2 trillion) almost equals the entire Russell 2000 Index.2 For the year, these five companies have returned a whopping 36%, standing in stark contrast to -7% for the remaining 495 stocks.3 This highlights the very narrow leadership behind this year’s rally in equities. By excluding this select group, the picture is quite different and certainly more reflective of the challenging economic landscape.

Chart: Looking under the hood of the equity market

S&P 500 Index returns YTD as of 7/31/20

Source: Bloomberg, as of 7/31/20. 1Top 5 stocks by market capitalization include Microsoft, Amazon, Apple, Facebook and Google. Average returns shown for Top 5 and S&P 500 ex Top 5.

Neutralizing the “best-in-class” companies

Understanding that industry leaders are typically well positioned to weather economic stress, it’s instructive to look at how all companies have been performing during this period. By looking at the same universe on an equal-weighted basis, we think we gain a broader view of how the average stocks in each sector performed this year. By giving each company in the index the same weight, regardless of its size, we essentially “neutralized” the effects of the largest companies.

When looking at equal weighted sector returns for the S&P 500, it is notable that only two sectors were positive for the year, IT and Healthcare, which have shown qualities ideal for the current environment. Once again, the few appear to have outdone the many. Aside from those two sectors, the other nine were in the red as there was little shelter for most stocks. Cyclicals, i.e., those most affected by the shutdown, have clearly struggled. We think that performance seen through this lens more accurately reflects today’s economic climate.  

Chart: Investors have shunned economically sensitive stocks

S&P 500 Index sector equally weighted returns YTD as of 7/31/2020

Source: Bloomberg, as of 7/31/20.

Understanding the current market

It is undeniable that equity markets have snapped back in a stunningly short period of time. It’s also worth remembering that the March selloff was just as swift. However, stocks have returned to their February high-water mark. We think this rebound may be misleading as many markets and securities still significantly trail their pre-COVID-19 levels. As a final observation, nearly 40% of S&P 500 stocks remain in bear market territory.4

The level of today’s S&P 500 likely reflects more of a flight-to-quality sentiment than investors adopting a risk-on posture. Uncertainty and challenges will, undoubtedly, persist in a post-virus world. Thus, investors have seemed fixated on quality, safety and growth during this phase of the economic recovery. In addition to traditional safe-haven assets such as US Treasuries and gold, they have turned to best-in-class stocks to satisfy this need. As the global economy continues on a path toward a stronger, broader and more sustainable growth trajectory, we would expect more cyclically oriented sectors to participate. This rotation briefly appeared in May but, with a virus outbreak in several states and the slowing pace of reopenings, investors returned to their favorite big tech companies. More recently, economically sensitive sectors have performed better, largely due to increasing prospects of another Congressional fiscal package, but when the equity rally does begin to broaden out, it will signal that the global economy is truly on the road to recovery.  


[1] Source: Bloomberg, as of 7/31/2020.

[2] As of 8/19/20.

[3] Source: Bloomberg, as of 7/31/2020.

[4] Source: Bloomberg, as of 8/19/20. A stock price experiencing a bear market is defined as trading at least 20% below its highest level over a trailing 52-week period.

The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.


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