Market Cap Trends – Q4 2020

By Bryan Novak

• Mega cap stocks have driven domestic stock market performance, by in large, in 2020. Might that be changing?
• Recent trends have seen changes in market segment performance such as small cap and value index performance
• Visibility into a COVID-19 vaccine may support a broader benefit for stocks, not just a few concentrated names

It’s hard to imagine in the year that has been 2020, after the deep collapse in risk assets in March, we would see such strong returns in any pocket of the equity market, especially when the U.S. economy and labor market have yet to recover to pre-pandemic levels. But that speaks more to the secular trend that has lifted not just technology stocks, but innovation segments. The U.S. and global economy were well entrenched in a techno-economic revolution, the likes we haven’t seen since the industrial revolution. This pump was primed and began well before COVID-19. The pandemic only exacerbated the differential between old and new economy. You can’t ignore this point, because in every short-term market move (the trees), there is a big picture to focus on that will drive value (the forest), and that is this.

There has been so much attention paid to mega cap tech and large/mega caps stocks, and for good reason. Return disparities have been great amongst broad equity benchmarks. Backers of the mega cap run use the backdrop I mentioned above to support further gains in this investment thesis. Naysayers, or mean reversion proponents, point to the few number of stocks that have been driving the majority of market returns, creating a wide disparity even amongst the major U.S. equity market indexes. This can be seen easiest in year to date returns (as of 11/13/20):

In Astor’s 2nd quarter conference call – we highlighted the discrepancy in returns between these stocks and the broader equity market. Despite the S&P’s strong rebound in the spring, many of the stocks that make up the S&P lagged the few mega caps heading into the third quarter.

Q4 has suggested a shift in these relationships may be occurring as we move into year end. Moving past election date was one obstacle to clear from a volatility standpoint (certified results or not at this point). But more importantly, early last week and again to open this week’s trading, positive results from Pfizer and Moderna’s COVID-19 vaccine trials, separately, provided some clarity on the unknown for the economy. Looking at return comparisons between market caps and market weighted indexes, we can evaluate trends in these relationships. Coming into 2020, the trends had broadly been favoring the large and mega cap stocks for some time. This accelerated as the pandemic took hold. Tech and new economy companies (i.e.; video calling, online retail, cybersecurity), broadly illustrated by the NASDAQ Composite 100 Index, benefited from the prevailing new reality.

Chart 1

One can see in chart 1 (above) that mega cap tech stocks pushed 120 rolling returns for the NASDAQ Composite 100 Index well above the S&P 500 Index into the middle of this year. To be sure, this trend was also visible in how the cap-weighted S&P 500 Index outperformed its equal-weighted brethren. The takeaway: diversifying U.S. equity exposure across market cap segments/styles was not as beneficial as in past periods. We’ve observed a reversion of sorts in recent months. The S&P 500 Equal Weight Index has held its own against the cap weighted S&P 500 over recent months and has started to outperform on a rolling 30 day basis (chart 2). A big reason for this has been small cap stocks. A persistent underperformer in recent years, small caps have begun to outperform on a relative basis in recent months. A further sign of encouragement may be found in the upside outperformance, not just relative (chart 3). This could be mean reversion or rotation, but still requires a catalyst.

Chart 2

Chart 3 This is not the first time we’ve seen signs of small cap and value-based indexes trying to make a comeback against their large cap brethren n recent years, so caution is always a virtue and context is prudent when digesting the data. Within our portfolios, staying the course is the ultimate objective. Allocating across ETFs helps to mitigate stock specific risk within the strategies. However, not all sector or market exposures are created the same, so being aware of concentration risk is necessary. We have been looking at ‘other’ options to mitigate risk to concentration, should mega caps move out of favor. This includes increasing exposure to alternate weighted indexes We have been increasing exposure to equal weight allocations such as for the broad S&P 500 Index and the technology sector. This part of the portfolio makes up 23% of the model weight as of November 16, 2020 for the Dynamic Allocation strategy*.

With a vaccine in sight (even if not here yet), the market has begun looking ahead for a move from the economy away from the stay-home model, even as the economy deals with the current reality pre-vaccine. We’ve seen an initial reaction that has favored value over growth, equal weight versus cap weight and small over large, all stemming from the same catalyst. Making wholesale changes against the competing backdrops may be a bit much, but we believe making complementary adjustments may benefit a portfolio in the long run.

DISCLOSURES

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Equal Weight: An index weighted across its constituents equally, regardless of the market capitalization of each holding. Rolling Calculations: Refers to calculations where each data point is calculated by summing a set interval of past data points (e.g. 36 month rolling calculation would consist of 36 months of data at each point).The Astor Economic Index^® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index^® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index^® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index^® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results. *The securities and weights represent the target allocations for the Dynamic Allocation strategy. Any individual investor’s portfolio may be allocated differently than presented here due to many factors, including but not limited to, timing of entry into the investment program, discretionary decisions by the clients and referring advisors, the structure of the invested product, custodial limitations, and/or the manner in which trades are executed. Securities and weights are subject to change without notice. The Dynamic Allocation strategy invests in Exchange-Traded Funds (“ETFs”). An ETF is a type of Investment Company which attempts to achieve a return similar to a set benchmark or index. The value of an ETF is dependent on the value of the underlying assets held. ETFs are subject to investment advisory and other expenses which results in a layering of fees for clients. ETFs may trade for less than their net asset value. Although ETFs are exchanged traded, a lack of demand can prevent daily pricing and liquidity from being available. Investors should carefully consider the investment objectives, risks, charges, and expenses of the ETFs held within Astor’s strategies before investing. This information can be found in each fund’s prospectus.

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