As of the writing of this commentary, the Dow is down 3.16% YTD. Though the indices have seemed to tread water so far this year, the entire S&P 500 index is being held up primarily due to the performance of a handful of large cap stocks resulting in bigger companies having a disproportionate impact.
While the benefit from this large cap bias is nothing new, it is so pronounced this year that it has masked how challenging it’s actually been for most stocks. According to a recent article from the Wall Street Journal, just six stocks—Amazon, Google, Apple, Facebook, Gilead Sciences and Walt Disney Co.—have accounted for over 100% of the gain the S&P 500 year-to-date. What this means is that on average, the other 494 stocks within this key stock market gauge have lost value since the end of 2014. Substituting Netflix for Walt Disney Co., these six stocks have also been responsible for more than half of the gains in the NASDAQ since the beginning of the year despite the fact that there are now more decliners than advancers.
This divergence between perception and reality is also evident in the number of stocks that have dropped to their lowest levels of the year even as the market overall remains not far from all-time highs. More than a fifth of the stocks within the MSCI USA Index (which tracks 640 large and mid cap stocks covering roughly 85% of the market capitalization in the U.S.) are now in bear market territory (down over 20% from their 200-day highs) despite the fact that the Index itself is off less than 2% from its 200-day high.
Because the majority of publicly traded stocks are smaller in size, it should come as little surprise that the alarming lack of market breadth is hitting them the hardest. For example, on an equally weighted basis, the S&P 600 Small-Cap Index was down 3.4% in July and 1.3% year-to-date. This is echoed by the Russell 2000 which fell 4.2% in July and 3.1% so far in 2015 on an equally weighted basis.
Add in the struggles we’ve seen in the energy sector, international fixed-income and equity markets, and even riskier domestic equities, and you have a rough few quarters for those properly diversified portfolios. Even Warren Buffet’s Berkshire Hathaway is down nearly 8% this year.
Some may say, why not be proactive and try to time these market events and concentrate your portfolio in only a couple of asset classes? History shows us that is an inappropriate and futile investment strategy. In fact, the latest study from The Dalbar Group finds the average retail investors return over the last twenty years is 2.5% versus the S&P 500 annualizing 9.9%. The reason is simple. Emotional decision-making has them selling after the market has declined, and buying back in after the market recovers. In our previous post, we showed the market declines over the last six years. However, the driving message of that post is the market, even with those pullbacks, is up over 200% during that time.
For those that follow the advice of those like Warren Buffet, Peter Lynch, Charles Schwab, and Jack Bogle, which is to stay diversified, you’ve experienced a pretty flat year. For those that have been concentrated in the very few positions that have done a bit better this year, consider yourselves lucky and give some thought to properly diversifying.
The key to market pullbacks is to stay disciplined, diversified and rebalance. Rebalancing the asset classes and sectors back into their proper weightings lets you take advantage of cheaper prices. It’s always nice to go shopping when there is a sale going on.