There were two big stock market stories in January, but the media only covered one. Here’s the story many investors missed, why it matters, and what to do about it:
The story you probably didn’t hear on the news
While the financial news focused primarily on how online stock trading message boards had created havoc in a handful of stocks, the bigger story in January was the clear divergence between large- and small-cap stocks.
Small-cap stocks have been on a roll, and they soared in January with the Russell 2000 up 4.9%. Large caps, which have been in favor for the last decade, have languished recently. In January, the large-cap S&P 500 and Dow Jones Industrial Average were negative, down -1.0% and -1.9%, respectively.
But don’t give up on large caps yet. Even after the sharp sell-off at the end of January, S&P 500 is not far off its record highs, and since the election most large-cap indexes are up more than 10% and the 12 month returns, except for the Dow, are fantastic.
The recent shift from large-cap growth to smaller-cap stocks is a theme we’ve been tracking for months now, and if it persists, it could herald a major market rotation. And a change in market trends could be the key part of investing in 2021, particularly if fears of a stock market bubble pan out.
Is this a stock market bubble?
The media has mostly focused on a potential stock market bubble as online day traders disrupted the markets and strategists pointed to some unnerving parallels between today’s market environment and the dot-com bubble in 2000.
Are stock prices too high? “By a variety of measures, including price to expected earnings and price to the past decade’s inflation-adjusted earnings, equities have never been so expensive outside of the dot-com bubble years," the Wall Street Journal explained.
Are we in another environment where individual investor money flows trump fundamentals? Bloomberg reported that “retail traders now make up a fifth of stock volume in the U.S., double the share of a decade ago.”
Or are low interest rates making stocks more appealing? “With interest rates at rock bottom and further stimulus on the table, many investors are being handsomely rewarded by putting their money into riskier, higher-yielding assets,” another Wall Street Journal article noted.
When there’s so much noise in the markets and even experts don’t agree on what’s going on, it can be hard for investors to know what to do. Should you lighten up on stocks in case there’s a sell-off, or will you miss out on further gains?
Our advice? Rather than trying to guess what the market might do in the future, focus instead on how you respond to changing markets and keep a close eye on changing market trends.
Why changing markets matter
Stocks may fall whether we’re in a bubble or not. Stocks have experienced declines in every calendar year back to 1980; on average, stocks lost about 10% during a given year. So it makes sense to plan for market shake-ups.
While it can be unsettling to notice the echoes of the 2000 dot-com bubble in the current market environment, it’s worth remembering that the dot-com bust didn’t affect every area of the market in the same way. Large-cap growth and technology stocks plunged, while value stocks had gains.
In challenging markets, some stocks typically hold up better than others, and that can turn out to be an important investment opportunity. Investors who are alert to these changes may be able to sidestep severe losses by shifting their portfolios into stronger performing areas.
This is exactly what our investment approach did in the 2000 tech bust: it led us to gradually sell out of growth funds and buy into value funds. It didn’t have perfect timing (we didn’t sell out of growth funds right before the market plummeted), but it helped us avoid much of the damage.
This year, if markets continue their shift from large-cap to small-cap (or growth to value or US to foreign), it could give active investors like us somewhere to turn.
What’s your plan for changing markets?
If you’re not confident about your investment plans in this ever-changing market, then this is a great time to work with an advisor. An advisor can offer clarity and perspective in uncertain times. FundX investment advisors specialize in helping people stay on course through changing markets for decades. Take the first step and set up a time to have an initial talk with a FundX advisor.