The economy is in rough shape, investors are feeling bearish, and yet stock markets were up strongly in July. What’s going on?
US stock markets notched their fourth consecutive monthly advance in July with the S&P 500 up 5.9%, the Dow Jones Industrial Average 2.6%, and the leading tech-heavy Nasdaq 100 7.3% for the month.
If you’ve been focused on US markets, you may not have realized that emerging markets outpaced US stocks for the second month in a row. The MSCI Emerging Markets Index surged 8.3% in July, while developed markets, as measured by the MSCI EAFE Index, were up just 1.9%.
Why are stocks up in this economy?
Why are stock markets up amid the most devastating economic collapse in nearly 75 years? Here’s a look at some of the factors at play:
1. Technology has an outsized impact on market indexes
Major stock market indexes, like the S&P 500 or the Nasdaq 100, are market-cap weighted, meaning that the biggest companies have the biggest influence. And these days the biggest companies are tech giants that have been doing well in the Covid-19 market.
Apple, Microsoft, Amazon, Google and Facebook now represent about 23% of the S&P 500. “Because these stocks are so dominating within the S&P 500, the index itself can close significantly higher at the end of a trading day even when most of the index’s stocks are declining,” Schwab explained.
Bloomberg pointed out that most of the other companies in the S&P 500 are suffering: “of the 500 companies in the S&P 500, about 450 of them are doing terribly.” Because these companies are so much smaller than tech stocks, they have less of an impact on the index.
“Department stores may have fallen 62.3%, but on a market-cap basis they are a mere 0.01% of the S&P 500. Airlines are larger, but not much: They weigh in at 0.18% of the index. The story is the same for travel services, hotel and motel REITs, and resorts and casinos,” Bloomberg noted.
What would the S&P 500 look like if every stock had the same impact? The Invesco Equally Weighted S&P 500 ETF (RSP) gives all 500 stocks equal weight, and it’s down -6.4% year to date through July 31, 2020.
2. Earnings are beating expectations so far
Second quarter earnings have been better than expected, particularly from tech companies, (although this is an admittedly low bar considering that earnings were expected to decline -40%). With roughly half of the S&P 500 companies reporting as of July 31, 2020, 80% had beat consensus estimates.
3. The US dollar has fallen
“The currency’s slide is adding further support to the booming market rally, lifting stocks and commodities,” the Wall Street Journal reported. Gold and precious metals funds were among the top performers in July.
A weaker US dollar can also be good for international stocks. “A weakening dollar also makes non-U.S. stocks, in both emerging and developed markets, more attractive for dollar-based investors,” Barron’s noted. Emerging market funds have done well recently.
What does this mean for fund investors?
It’s good to keep up with what’s happening in the markets, but you still have to know what to do about it in your fund portfolio. And while markets have sailed through the summer of 2020 thus far, there are still plenty of reasons to be cautious.
The economic downturn has wiped out five years of growth, and no one knows how long it could take to recover. And the US is still struggling to control the Covid-19 virus, which has taken a toll on consumer and investor confidence.
The American Association of Individual Investors (AAII)’s weekly survey of investor sentiment recently found twice as many investors were bearish as bullish, one of the more bearish readings on record. And yet, this could be a reason to get more invested. Historically, when sentiment has leaned this far bearish, it has been positive for stocks over the next year.
If you’ve been out of the market or you got more conservative earlier this year, it’s worth thinking about how you might start to participate again. Remember you don’t have to be all in or all out of the stock market; there are many ways to participate at many different risk levels. Talk with your advisor about what’s right for you.
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