by Liz Ann Sonders, Chief Investment Strategist, Charles Schwab & Company Ltd.
LIZ ANN SONDERS: Hi, everybody. Welcome to the April Market Snapshot.
So as many regular viewers know, I like to switch back and forth. Sometimes I’ll focus more on the economy. Sometimes I’ll focus more on the market. And I want to focus on the market in this environment because of not just the correction that was earlier in the year, but the recent rally and do a little bit of a look under the hood, look at the anatomy of what’s been happening, and maybe what some of the underlying messages are from how the market has been behaving.
So I want to start with this drawdowns table. I often put this on my Twitter feed for those that follow me. I’ll sometimes make some adjustments to what, in particular, were looking at, but, in essence, it takes a look at three of the major averages. You’ve got the S&P, the NASDAQ, and the Russell 2000. Then you’ve got the left section. As you can see at the very top, is year-to-date data, and then the right section is past 52 weeks data. So you look at the case of index maximum drawdown, that’s just at the index level. At the index of the S&P, NASDAQ, and Russell, what was the maximum amount of weakness that we saw on a year-to-date basis? Jump over three columns, you can see the same thing. What was the index maximum drawdown from a 52-week high? And that’s where you get metrics like, okay, are we in a bear market? Are we not? If it’s more than 20% using the traditional definition, it’s a bear market decline, as we have seen recently for both the NASDAQ and the Russell 2000.
But where I have these boxes now in red, this is what I want to focus on. This is where you peel the onion back one layer and look under the surface. So this is the average member maximum drawdown. So you go across, in the case of the S&P, all 500 stocks, look at each one individually. What was each stock’s maximum decline either year-to-date or relative to a 52-week high? And then average all those numbers to come up with these numbers. So you can see that under this surface, the weakness has been more significant. On a year-to-date basis, we’re almost at minus 20% for the S&P in terms of the average member drawdown from a year-to-date high. Even worse, minus 25% if you look to the right relative to the high in the past 52 weeks. And you can see it’s even worse for both the NASDAQ and the Russell 2000.
Now, we had a rough start to the year, the first two months of the year. Basically, January 3rd to about March 8th was the corrective phase. You didn’t quite hit bear market territory using that traditional definition for the S&P, but, again, you did for the NASDAQ and the Russell. Then the market found its footing around that March 8th low, and then had a pretty significant rally after that. Now, there’s been a lot of focus on what caused a correction, what caused a rally, how much of it was Fed policy, how much of it might have been the war? The answer is probably all of the above, but there are other factors that I think come into play that are not the obvious headline factors of the war, or even Fed policy rate hikes, but kind of the background conditions. As many regular viewers know, I focus a lot on investor sentiment. At extremes, it tends to serve as a contrarian indicator. The market tends to go opposite the way sort of investors are either positioned or how they feel about the market, but it usually requires a bit of a catalyst.
So this is one measure of sentiment. It’s the American Association of Individual Investors. It’s a weekly survey that a AAII, for short, does with their members. And this is just the percentage of bearish respondents. Those saying they’re a bear. They don’t like the market. They’re negative. And back in the November period of time last year, you had had a very low level of bearishness. Then you started to see that change with regard to Fed policy. But coming into the beginning of this year, you still had the bears representing less than 30% of the entire group. That suggested that there was not enough pessimism, that there was more optimism, there wasn’t a lot of people expecting a downturn in the market. That provided a bit of the setup for the decline that started on January 3rd. Then we went through that two month decline and along the way, maybe no surprise, investors became increasingly more bearish, until the point where we hit early March, bearishness was at a very elevated level, more than 50%, and that, to some degree, provided a setup for the rally that then happened. So, certainly, financial, the press, when I talk to them all the time, especially if they’re talking about an individual day’s action or a week’s action, they want to know what’s the reason? What can you pinpoint? They’re always looking for the headline. Sometimes it’s just the more subtle background conditions that come into play. So we’ve had this rebound again, March 8th was the low, you can see that in the vertical line here. These are the same three traditional averages. You can see the downturn that carried into that low, and then the move that we’ve seen up which has been in the, you know, single-digit to a little more than double-digit territory for those major averages.
But there’s been more strength in other segments of the market, and here’s where we sort of dive into the anatomy of this rally. These are what I call the spec areas of the market, spec, being short for speculation driven. We’ve talked about this a lot on these broadcasts. Some of these pockets of the market that have historically been driven by rampant amount of speculation, they’re arguably lower quality segments of the market. You’ve got retail favorites, that’s just retail investors or favorite stocks; most shorted stocks; SPACs; the meme stocks, always very popular; and then non-profitable tech as a theme. So those are just a handful of them, but ones I focus on a lot. And you can see in those cases, the rebounds have been more significant, upwards of almost 30% in the case of the meme stocks in the first few weeks of the rally. That tells me that a lot of that was just bottom fishing, reversion to the mean, speculators attempting to go back into areas that had done well at times in the past. I’m not sure that the message from this rally is ‘All clear ahead, things are looking better broadly for the market, specifically for the economy.’
And one of the reasons is what hasn’t been working in relative terms during this rally. So this is just the S&P 500 going back the past year, that’s the blue line. To put it into context, these are a number of industries. These are not sectors, one level down industries that are considered highly cyclical. They basically represent a direct tie to what’s going on in the economy. If you were in a rally phase in the stock market, and the more cyclical areas were leading, that would be sending a more positive economic message. Conversely, what’s been happening is that what’s been lagging in this rally has been nearly every industry that is directly tied to the economy. That’s a less benign message that the market is sending that, ‘Hey, we’ve got some trouble ahead in the economy, and we’re reflecting that in what is underperforming.’ This idea that the market being driven by low quality, low earnings companies is a sign of sort of, you know, a bright spot on the horizon, I think that’s where the analysis falls short a little. There’s so much focus just on index level changes that I think to get the real message of the market, it requires us digging at least one below the surface.
Here’s another way to look at the difference between what was happening during the corrective phase for two months and then what’s happened in the rally. We know that earnings, ultimately, tend to drive stock prices. So this breaks a broader average than just the S&P. It’s the Russell 3000, the 3,000 largest stocks in the market. So it covers most of the US stock market and breaks it into deciles based on the amount of earnings growth of the companies. Decile one is the lowest earnings. Actually, most of the stocks in that decile don’t even have earnings, they’re negative earnings companies, they have, you know, less than positive earnings growth, all the way up to the highest earnings quintile… or decile, I should say. And you can see, as maybe one would expect when you’re in a correction in the market as we were earlier in the year, the worst stocks were the ones that have no earnings or had very, very low earnings growth, and in relative terms, the best stocks were the ones with higher earnings. What’s happened since the low? In this case, you’ll see March 14th. That differs from March 8th because that was the low in the Russell 3000, and that’s the broader index we’re looking at here. But you see almost a mirror image. The best performance has actually come in the stocks that have the weakest fundamentals, including the lowest amount of earnings growth. I would be really careful about chasing that kind of performance, given the lack of a fundamental underpinning in terms of what is happening.
If we look at the sector level, a couple of points we can make about this. This is a quilt, as we call it, that I’ve shown in the past. Oftentimes… you’ve probably seen other firms show a version of this. It’s a very popular way to show either sectors or broader asset classes, and then ranked by performance. But most of these sort of generic quilts that are shown are broad asset classes, and it’s year by year, with the message being this is why we need to be diversified. In this case, I’m doing it at the sector level, and I’m doing it month by month. So it just covers the past year of data. It’s all 11 sectors that make up the S&P 500, and, again, going back a year, it ranks them from best to worse. And one of the overarching messages about this is when you just quickly look you don’t see any color pattern. There’s no sort of theme, consistent theme, in terms of what’s at the top, what’s at the bottom.
So one forever message that should come from looking at analysis like this is the benefit of being diversified. In particular, there’s a unique amount of sector volatility in this environment, in large part due to the unique uncertainties associated with Fed policy, COVID, of course, and now the war in Ukraine. And it’s one of the reasons why a few weeks ago, we actually neutralized our sector recommendations, and said this is not the time in the market cycle to try to pick the sector or two sectors that are going to perform well.
We can look at that far-right column and see that energy has been, by far, the best performing sector over this entire period of time. However, I’m now going to show you what the energy sector has done on a month-to-month basis with this yellow line. Talk about all over the quilt. I think investors, unless they really want to try trade this and think they can do it successfully, getting in at the right time, out at the right time, this tells you that even an asset class that has done well, like energy, or a sector that has done well, there’s a tremendous amount of volatility it took to get to that level.
Let’s do the same thing at the broader asset class level. So this covers everything from large-cap US equities, to small-cap, to emerging markets, to REITs, we’ve got international in here, we’ve got segments of the bond market like TIPs and developed bonds, so it’s the gamut, all the way to cash as measured by T-bills, and, again, ranked month by month. Go over to the far-right column and you see that COM, which in this cased, is commodities, maybe no surprise, given what’s been happening with inflation, and energy prices, and food prices, commodities have been, by far, the best performing asset class. On the other end of the spectrum, you’ve got emerging markets as the worst performing asset class.
But even with that strength in commodities, one might say, ‘Oh, I should have just been in commodities.’ Yes, if you have the wherewithal to stick with it, but much like this energy, take a look at the path that commodities have taken along the way. There’s just much more short-term money in the market right now, trading in rapid-fire fashion, where you can see prospects for certain asset classes and sectors really turn on a dime, and it’s just a bit more treacherous an environment to try to play the tactical or short-term timing game.
But, more broadly, both of these quilts reinforce diversification. In temporarily removing our tactical recommendations, we’re really reinforcing that investors should have a plan, have a strategic asset allocation plan, be diversified across and within asset classes, and then the way to navigate this type of action, this almost perfect W in the case of commodities or any other volatile asset class or volatile sector is use rebalancing to your benefit. We know it’s a part of a disciplined process, but, as a reminder, what rebalancing does, when our portfolio gets out whack certain asset classes become a larger share or a smaller share based on short-term performance. Rebalancing forces us to do what we know we’re supposed to, which is, to use the old adage, buy low/sell high. My sort of a balancing version of that is add low/trim high, and, actually, take advantage of some of this volatility to keep yourself at your core strategic asset allocation and take advantage of the swings that we’re seeing that can be quite dramatic, as opposed to trying to anticipate them upfront.
So a bit of an anatomy of what’s been driving the market, but I wanted to end it with some of these tried and true disciplines that even in a trickier market environment, ultimately, pay dividends, maybe figuratively and literally. So thanks, as always, for tuning in.
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