The market’s sharp rebound from a similarly sudden downturn is primarily driven by a few stocks.
On one hand, this reality provides investors with the opportunity to pile into the megacap tech stocks that largely dictate the market’s direction. After all, their impact on marketwide gains and losses has grown over the past decade, especially within indexes like the Nasdaq composite that are weighted by market value.
But this feature is becoming a bug in light of the ongoing economic downturn. That’s because tech stocks are vastly outpacing parts of the stock market that would normally recover the fastest.
The spectacular performance of these seven companies is “leaving an impression of the March sell-off as if it were a mere blip in the still roaring bull market of yesteryear,” Andrew Lapthorne, the global head of quantitative research, said in a recent note.
His team’s study of how stock-market factors performed during S&P 500 drawdowns of 30% or more since 1928 showed a very different set of leaders on the way up.
The historical script derived from these severe episodes includes a crash in the equity factor that prizes the best-performing stocks — also known as momentum — after a market bottom. Defensive stocks that offered protection on the way down also fell out of favor historically as investor money rotated to cyclical companies that benefited from the recovery.
During this rebound, however, cyclical stocks began to convincingly pick up pace only this week, with sectors like industrials and financials leading the S&P 500 while technology lagged. According to Lapthorne, the performance of classic cyclicals since the March bottom has been inconsistent at best — a reflection of the uncertainty that surrounds a potential vaccine and the economy’s reopening.
Lapthrone further isolated crises that bear some semblance to the ongoing one to find out whether any major differences exist.
He did not find significant departures: Bear markets that were supported by heavy doses of monetary and fiscal policies — such as this one — typically showed a clear-cut rotation to cyclicals. Investors understood how committed policymakers were to reigniting the economy and aligned their portfolios accordingly.
This time, investors’ alignment has largely been to the big tech stocks that are benefiting from remote work and communication — not necessarily those traditionally tied to economic recovery.
Even a consideration of the market’s evolution over time did not lead Lapthorne to significantly different outcomes. He further isolated bear-market incidents to the post-1980 period and found that cyclicals gained more than 20% on average within the first year of a recovery, while price momentum and defensive strategies fell far behind in the early months.
“The whipsawing of cyclical performance, which is far short of the historical classically clear resurgence as a vote of confidence to an upcoming economic recovery, could also raise questions about whether the worst is over for the markets,” Lapthorne said.