The Stock Market May Be Performing Worse Than You Think

The most common question I hear these days is a variety of “Why isn’t the stock market reflecting the carnage in the broader economy?”. I broadly addressed this topic in a recent post but one part of that answer deserves a little more explanation.

Importantly, when people talk about “the stock market”, they are generally referring to the S&P 500 Index and/or the Dow Jones Industrial Average. These two benchmarks are ubiquitous and hard to avoid. Ask someone how the stock market did today and you will assuredly get a response that directly or indirectly references one of those two indices.

This 2016 article explains why the Dow is a terrible accident of history and that it is only history, name recognition, and habit that cause the world to continue using this index as a reference point. The other index that we collectively use to represent the stock market – the S&P 500 – is a far better representation of the domestic stock market. Yet it is far from perfect.

One big issue with identifying the S&P 500 Index as “the stock market” is that the S&P tends to be overwhelmingly influenced by a handful of large companies within the index. That concentration has never been more impactful, historically, than it is right now. Just five companies – Microsoft, Apple, Amazon, Facebook, and Google (Alphabet) – represent approximately 21% of the Index. The larger these companies get relative to the rest of the stock market, the more dominant of an influence they have on the index.

As a result, these five stocks skew our perception of how the stock market, in a broad sense, is performing. Consider, for example that cruise line stocks are down 70-80% this year. Retailers have generally lost 50%-65%. Oil and gas exploration and production companies are down 55% – 65%. These industries have justifiably been devastated by the pandemic but the devastation is being obscured by the way the index is constructed. While 14 stocks representing these industries have declined by an arithmetic total of 869% this year, their total impact on the S&P 500 is offset entirely by Microsoft’s 14% gain in 2020.

A similar phenomenon holds true for the airlines in the S&P 500 – all of which have lost between 50% and 74%. The aggregate decline of all the airline stocks in the S&P 500 during 2020 – an arithmetic loss of 311%- is entirely offset by Apple’s 4% gain.

This tends to be an important source of confusion when people question why the “stock market” is not depicting the carnage on Main Street, The reality is that most stocks are reflecting the harsh realities of the pandemic. Airlines, retailers, apparel makers, lenders, cruise lines, hotels, financials, automakers, leisure and entertainment companies, and oil and gas companies have all been devastated this year. As of May 20th, over 1/3 of the stocks within the S&P 500 have lost more than 27% of their value.

But that carnage is being masked within what we define as “the stock market” by the performance of five stocks that have a dramatically disproportionate impact and have, for different reasons, continued to do well amidst the pandemic. Just something to keep in mind the next time you’re confronted by someone who questions why the stock market isn’t reflecting the harsh economic realities of Main Street.