The year 2020 has turned out to be an unprecedented year. We have received calls from many of you concerned about how COVID-19, the state of the economy, and the election outcome might affect markets and, more specifically, portfolios. While it can be difficult to determine how these complex and converging issues will influence the global economy, it is important, now more than ever, to focus on economic fundamentals and exercise investment poise.
Driving Factors of Market Uncertainty
There are three forces driving what’s happening in the markets today. The virus (COVID-19), the economy, and in the short-term, the election.
In terms of the markets and the economy, the sooner the nation receives a vaccine, the more clarity we’ll have in terms of what our new normal will look like. We believe that elements such as COVID-19 therapeutics and a viable vaccine, will help reduce any continued economic damage to our economy.
The good news is that the stock market recovered nearly all losses experienced between March 23rd and June 30th, however there are important aspects to note.
There seems to be a disconnect right now between the stock market and the economy. The stock market is forward-looking, and we are seeing an improvement in certain parts of the economy. The concern about the stock market is only a few sectors have shown gains while the rest of the S&P 500 has a slight negative return for the first six months of the year.
The FANG stocks (Facebook, Amazon, Netflix, and Google) has expanded to include both Apple and Microsoft – now considered FAANGM. These six stocks have increased significantly in value. (see chart below)
Looking at growth and value, year-to-date, value is down significantly. For the first six months of the year, the Russell 1000 Growth was up 9.81% and the Russell 1000 Value was down 16.26%.1 This feels akin to the late 1990s and what the markets experienced during the technology bubble. In the current market environment, the 50 most expensive stocks in the S&P 500 are trading at a price-earnings ratio (P/E ratio) of over 75, which is four times the market’s long-term average.
This chart below shows that over 10-year lookbacks since 1937, value stocks have outperformed growth stocks with the exception of three periods in time2.
Independent of that, when we look at a stock such as Tesla (NASDAQ:TSLA), they have a P/E ratio over 1,000 and their forward-looking P/E is over 300. In comparison, the P/E ratio on the stock market is historically 17.1
The P/E ratio in the late 90’s was 24.3
As of early September, the FAANGM stocks dipped an average of -12.8% including -18.2% for Apple. This highlights how quickly some of these stocks can correct.
Still, the current high market valuations are being driven by the FAANGM and other technology stocks. This is not necessarily a bad thing, but the P/E ratios are something to watch closely.
Our hope is to see the valuations look more like what we saw in the pre-COVID period.
The recent stock market rally since March 24th, has given the market four to six years of returns (for normal equity returns) in less than two months. But the downside risk in the global economy still exists.
What Should You Do as An Investor?
During these times and until we better understand longer-term resolutions to the COVID-19 pandemic, we recommend you consider three things:
- Be committed to investing and take a long-term horizon view.
- Diversify your investments because asset allocation has shown to work well historically.
- Focus on your short-term liquidity needs. During periods of volatility and circumstantial uncertainty, it’s prudent to measure what cash you’ll need months to years into the future.
We will wait and see how the markets respond to who will be elected or re-elected in November 2020. As November approaches, there will be more questions and concerns about what will happen in Washington.
As always, we are here to answer any questions you may have. We hope you and your loved ones have a happy and healthy remainder of 2020.
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2Source: Dodge & Cox, March 31, 2020. (a) Monthly observations, data ends February 29, 2020 (latest available).Calculated based on data from Kenneth French’s website (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/index.html), which was derived from the CRSP (Center for Research in Security Prices)/COMPUSTAT merged database. CRSP recently completed a data series project that added new daily data, which resulted in changes to month-end prices and dividend ex-dates and also changed historical returns on French’s website. This chart includes the restated data as of July 31, 2017. (b)High minus Low (HML) is one of three factors in the Fama-French model and accounts for the spread in returns between value and growth stocks. The Fama-French portfolios used to calculate the chart above include all NYSE, AMEX, and NASDAQ firms with the necessary data. The above information is not a complete analysis of every material fact concerning any market, industry, or investment. Data has been obtained from sources considered reliable, but Dodge & Cox makes no representations as to the completeness or accuracy of such information. Opinions expressed are subject to change without notice. Before investing in any Dodge & Cox Fund, you should carefully consider the Fund’s investment objectives, risks, and charges and expenses. To obtain a Fund’s prospectus and summary prospectus, which contain this and other important information, visit dodgeandcox.com or call 800-621-3979. Please read the prospectus and summary prospectus carefully before investing.