The S&P 500 bears an extreme risk: too few stocks account for too much of its weight. The index is experiencing extreme concentration risk not seen in the last 30 years, with its five largest stocks now accounting for more than 20% of the entire index.
The chart below shows just how out of balance the weightings of the largest S&P 500 stocks have become. Currently, the total index weight of the five largest holdings is more than five standard deviations1 above normal.
Innovation within the biotechnology, medtech and diagnostics industries makes the health care sector an exciting area to invest. Valuations also make it precarious.
At Dana funds, we have balanced the risk and opportunity within the sector with a steadfast focus on valuation discipline. We are investing in innovation within the sector – but at what we believe is a reasonable price. We also find opportunity with companies that have simpler stories, but nevertheless benefit from long-term, secular tailwinds affecting health care.
Stocks within both camps have been large contributors to performance over the past year, and are a primary reason stock selection within the health care sector has contributed to relative performance for our Epiphany Fund.
It’s a natural reaction to every bear market. As stocks plummet, clients start wondering whether they should pull money out of equities and wait on the sidelines until conditions improve. If you’re an advisor, you may have had several conversations along these lines recently. We salute your efforts to help clients stay the course.
At Dana, we realize the importance of staying fully invested and reflect it in our investment process, which dictates that funds hold minimal cash. Our view is that it is always better to stay fully invested because not even experts can perfectly time a rebound.
However, we know it can be challenging for advisors to keep their clients invested through a downturn. In the spirit of helping, below are five quick-reference stats and charts we’ve collected that paint a picture of why we believe it’s important to stay in equities through the entire market cycle:
As 2019 ended, the backdrop for the energy sector looked relatively solid. Oil prices were up more than 30% in 2019, and future demand appeared firm, as cooling trade tensions between the U.S. and China led many to believe the economy would improve.
It would have been hard for nearly any expert to predict what would happen next. The coronavirus has severely affected the global economy and, in turn, sapped energy demand. At the same time, a price war between Russia and Saudi Arabia has also driven oil prices lower. As a result, the S&P 500 energy sector is down nearly 52% this year, trailing well behind the next biggest sector laggard – financials – which is down 31%.
On the other hand, heading into 2020 few would have predicted utilities would be the best performing sector, down 13% so far this year, but outperforming others due to its defensive nature.
The only thing more striking than the depth of the recent market rout is its speed. It took the S&P 500 just 22 days to fall 30%, the quickest drop of that magnitude in history. The fast freefall has left little time for equity strategies touting downside protection to deliver it … but give it a moment. Stock selection can help navigate equity market downturns, but it provides greater value over a longer period than three panic-stricken weeks.
At Dana, we pride ourselves on the ability to outperform in sustained bear markets and our strategies did so through both the tech bubble and great financial crisis. This is largely what we would expect, given our investment process. We focus on high-quality companies that trade at a discount to their peers. These companies tend to outperform when the economic outlook sours and the rest of the market gravitates toward companies with stable balance sheets and steady earnings growth.
We see early signs the market is once again starting to differentiate between high and low-quality companies. But a bias toward smaller companies and a tilt toward value hasn’t yet helped us in the current downturn.
As stocks slid from record highs to bear market territory in a matter of days, not months, the thing that would really make a strategy shine in the current market environment is to increase one’s allocation to cash. We view this as a market timing call, however, and it’s simply not what we do.
Is Your Manager a Timer or an Investor?
In the earliest stages of a bear market – particularly this one – the best way to cushion the fall is to hide in cash or short equities. Undoubtedly, there have been some long-only managers that have probably benefited from holding excessive cash positions during the recent rout.
With stocks crossing into bear market territory, it’s been a tough period for equities. But credit the market sell-off for one thing: it’s been discerning. Stocks are down broadly, but lower-quality companies bore the brunt of the sell-off.
The volatility underscores why we take a high-quality approach to stock selection. In volatile periods the market typically recognizes stocks of companies with greater earnings stability and stronger balance sheets. Conversely, companies with higher debt levels or speculative growth models are typically punished harder in market downturns and have been again in March.
We believe holding a portfolio of these higher-quality companies leads to outperformance in periods of market stress, and, in turn, better relative performance over a full market cycle. The recent volatility underscores the value of this approach.
We’re proud to announce that our Dana Large Cap Equity Fund - Investor share class (DLCEX) hit its 10-year track record on March 1st, 2020. The Fund has returned 218.38%, an annualized return of 12.28% over this period.1
“10 years ago, we chartered a new course to serve investors with a mutual fund offering. In these volatile times, we are proud to reflect on our accomplishments this past decade and pleased to have generated such strong positive performance for our fund shareholders. We believe in today’s current environment it is more important than ever to stay focused on the long-term goals.” Mark Mirsberger, CPA, Chief Executive Officer
Fear is the virus on which the news media thrives.
Viruses are with us everywhere and always. Illnesses defined under the umbrella of influenza kill between 10,000 and 50,000 Americans each and every year. Total annual deaths in the U.S. are about 2.8 million, so influenza makes up less than 2% of those deaths. Video of personnel in gowns and masks carrying sprayers invoke the fear response.
Past influenza epidemics include the 1957-58 Asian flu, the 1968 Hong Kong flu, and the 2009 Swine flu. The H1N1 Swine flu appeared in the United States first. There were estimated to be 60 million U.S. cases, but only 12,000 deaths. Worldwide, the Swine flu is estimated to have killed 200,000-500,000 people. 80% of those deaths were people under the age of 65.
So what do we know so far about the current Coronavirus?
What a difference 15 months makes. In the fourth quarter of 2018, the market was down almost 20% through Christmas Eve and had dropped over 10% in just the middle two weeks of December. Jerome Powell had just led the Federal Reserve to the fourth interest rate increase of 2018. Regardless of the market drop, Powell seemed to have a ‘what, me worry?’ attitude. He said that the balance sheet reduction was on autopilot.
Throughout 2018, we feared that the Fed was an unwitting enemy of both the markets and the economy, and that became clear at year-end. Powell tempered his tone, and the Fed embarked on what seemed like an interminably long pause until it cut rates at the end of July 2019. During that period, the ten-year Treasury yield fell below short-term rates in late May and remained there until early October. The equity markets traded in a range through the summer and fall, and only moved to new highs just before the last Fed cut in October. Since then, the move upward has continued with markets constantly nearing all-time highs. The Fed has since telegraphed an ‘on hold’ policy going forward.
The once red-hot market for unicorn investments has turned chilly. These start-up enterprises with a value of at least $1 billion have enjoyed relative easy access to private capital this cycle. Robust growth, easy credit and a fair amount of hype combined to elevate the early valuations of these companies. Peloton Interactive, Inc. (PTON), the maker of stationary bikes and treadmills, marketed itself as “selling happiness.” Ridesharing company, Lyft, Inc. (LYFT) claimed it was “at the forefront of societal change.” Corporate real estate leasing company WeWork aimed to “elevate the world’s consciousness.”