Aggregation, Consolidation and Allocation

After a sharp sell-off Tuesday, following the three day Labor Day weekend, the stock market fell into a consolidation period the remainder of the week. The consolidation period witnessed fairly dramatic intraday swings, with little overall progress made one way for the other from Wednesday through the end of the week. For now the market still seems to be at the mercy of a few heavily followed momentum stocks. Apple, Amazon, Google, Facebook and Microsoft represent nearly a quarter of the weighting for the S&P 500. These 5 stocks, on an equal-weighted basis, are up over 40% year-to-date. By comparison, the cap-weighted S&P 500 is up only 4.84% (of which those 5 have an outsized impact), while the equal weighted S&P 500 Index is actually down 4.94%. While it is possible to imagine a world where we see a mean reverting move in the market which pushes the rest of the stocks higher while those big tech names lag, a more plausible reality is that the market will ultimately be pulled in the direction of those few stocks.

The 6-month long narrative has been the pandemic has been a boon for tech. It has seemingly catapulted our society 10 years forward in the course of 6 months. If World War II forced the US to go from having an army smaller than Portugal’s to the most powerful on Earth in a matter of years, coronavirus has forced similar seismic shifts in our society. But this is the stock market, not a shampoo, we can’t just buy, rinse, and repeat and expect the current environment and narrative to carry us in perpetuity. All trends eventually run their course and Sir Isaac Newton’s pesky discovery eventually emerges.

When gravity will pull this market down still remains to be seen. There are many longtime market players, like Stanley Druckenmiller, who have been quite outspoken about the current market being a bubble, not unlike the 2000 bubble. Others are found of pointing out that we have only recently emerged from a bear market and thus are in the early stages of a new bull market. Myself, I tend to side more with the former than the latter. The fact that the S&P 500 was only “under water” for all of about 6 months hardly feels like a bear market scenario. The fact that the Nasdaq 100 Index is now, even after last week’s correction, is over 15% higher than the pre-pandemic February highs. Visually and emotionally this market feels more like late-stage bull market euphoria than an early bull market. That being said, the Nasdaq certainly could have been called a bubble in December 1998, but the next year it still managed to go up another 100%.

Bubbles can form and linger for longer than we typically realize. One reason being is that we typically only recognize the bubble after it has popped, and then we typically only ascribe the bubble quality to the very final stages. From March 1997 to March 2000 the Nasdaq witnessed a 500% gain, by the time the bubble deflated all those gains were wiped out. The Nasdaq 100 wouldn’t visit those March 2000 levels again until 2015. Whether this tech correction over the last week is the beginning of the end, or just one more dip buying opportunity still remains to be seen. But if we truly are in late stage bull market euphoria, then discretion remains the better part of valor. To that end, one method we find valuable is to utilize a cash allocation as a means of preventing over-exposure to adverse market moves. While not seeking to time the market entry and exit points, we see cash as a means of managing market exposure.        

Thanks for reading,

Zach and Dave  

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