Time to Read: 6 Minutes

In our October webinar, we highlighted the potential for the election to create added volatility driven by the possibility of a contested or drawn-out process. In fact, the Dow Jones Industrial Average (DJIA) fell 6.5% the week prior to the election—its worst pre-election week on record, according to Ned Davis Research (NDR).

Almost one month after election day, President Trump has yet to concede and the fate of the Senate hinges on two run-off elections in Georgia slated for early 2021—yet the DJIA hit a record of 30,000 just last week. Why are markets responding so favorably? We explore two key reasons and discuss our recent portfolio rotation.

Markets get comfortable with the apparent election outcomes

Although the 2020 elections have not been finalized, it seems markets have become comfortable with the following likely outcomes, which represent a check on the balance of power:

  • Joe Biden and Kamala Harris are likely to be our next president and vice president
  • Republicans are likely to retain their majority in the Senate
  • Democrats will retain their majority in the House of Representatives.

As shown below, the DJIA has enjoyed its best performance during periods with a Democratic president and split Congress.

Rapid vaccine progress provides additional tailwind

Markets have also been boosted by stunning progress in producing multiple vaccines for COVID-19. Three major pharmaceutical companies recently released favorable results from clinical trials of their vaccines, including very promising news from Pfizer and its partner BioNTech along with Moderna, which each reported vaccines that are 95% effective in trials.

This news could not come soon enough as communities worldwide experience another major wave of cases, deaths, and lockdowns. Interestingly, markets are beginning to rotate out of the high-flying “COVID leaders” and into the beaten down “COVID laggards,” as illustrated below.

We first wrote about NDR’s COVID leaders and laggards in May. The top panel of the graphic above shows relative performance of leaders vs. laggards. When the line is rising, the “stay at home” leaders are performing better; when it is declining, the laggards are outperforming. The bottom panel shows the number of new cases in the US. There is a clear relationship during the first two waves of the virus: As cases rose in March/April and June/July, leaders outperformed. This relationship, however, has broken down recently. We believe this breakdown is attributable to better-than-expected vaccine news. Markets are beginning to look ahead toward a reopening of the economy—even in the face of rising cases.

Assessing the investment implications

We believe this change has implications for the broad market, as much of the performance of US stocks in 2020 has been concentrated in a handful of technology companies which have benefited from the pandemic. Because the S&P 500 Index is weighted according to company size (i.e., market cap), companies and sectors become more concentrated in the index as they grow larger. In fact, the current weight of the top five stocks in the S&P 500 is greater than 22%, a level not seen since the early 1970s and surpassing the dot-com bubble of 2000.

We believe this concentration presents an opportunity to look at the S&P 500 differently, as an equal-weighted index, where each company holds the same weight regardless of size. As shown below, the S&P 500 Equal Weight has significantly outperformed the market-cap weighted S&P 500 since 1971.

As one might expect, however, the market-cap weighted version performs better when concentration in its top stocks is high, as shown below.

While we still think it always makes sense to have a core holding in the market-cap weighted S&P 500, this week BWM began to add exposure to the equally-weighted index while continuing to reduce exposure to the technology sector. We believe the market will eventually look ahead to a full reopening of the economy, which should benefit equally-weighted exposure and provide continued upside to equities. If our objective indicators continue to improve—which would occur should the market rally hold and participation continue to broaden—we would look to increase our equity exposure.

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Investment advice offered through Stratos Wealth Partners, Ltd, a registered investment advisor; DBA BWM Financial. Stratos Wealth Partners and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only; and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.