This week has been welcome relief for investors who are still struggling to digest a month in which 97% of the stocks in the S&P 500 are down and the market as a whole has dropped 25% from its peak.
The aggregate numbers are daunting. Every sector has at least suffered a 10% correction, and several remain deep in bear market territory. But we don’t invest in “the stock market” as a whole because we know how easily a few truly weak spots can mask strength elsewhere.
For us, focusing on strong spots, while avoiding obvious pain points, keeps the profit flowing. It is how we outperform year after year. And now that relative winners and losers are finally emerging after weeks of near-universal correlations, it’s time to focus on strength.
Narrow Your Screens
The last month hasn’t been as apocalyptic as the numbers suggest. Massive selloff days have alternated with strong bounces, leaving the market as a whole roughly where it would be at this stage in a normal correction cycle.
Remember, we survive two to three significant downswings a year and statistically half of them take more than 10% away from the S&P 500 before the bulls get back to work. Even 20% bear markets aren’t as rare as some people think.
The S&P 500 crossed the red bear market line in 2011 and again in 2018. While the entire post-2008 era may look like an uninterrupted golden age in the rear view, Wall Street reality, simply as we lived it, was a lot more volatile.
Furthermore, most of the market’s recent pain is clustered in very narrow and easy-to-avoid segments. Cut them out of your portfolio or underweight them, and you’ll feel a lot of relief.
Start with energy. These stocks are only 3% of the S&P 500 by weight but the oil slump has contributed 8% of the broad market’s recent downswing.
I don’t see oil coming back immediately. Cut the entire energy sector out of your portfolio until it bottoms and starts to rise again.
Then there are the banks. Finance is a much bigger piece of the S&P 500, but it also has dramatically underperformed.
If you’re afraid of another Lehman Brothers credit crash despite the Federal Reserve’s best efforts, steer clear of the big banks. But the little banks haven’t done well, either. Avoid the entire sector.
I’ll make an exception for Berkshire Hathaway Inc. (NYSE:BRK-B) because it has a foot in the real economy as well as finance. And now is the time to load up on electronic payment stocks like Visa Inc. (NYSE:V), Mastercard Inc. (NYSE:MA) and PayPal Holdings Inc. (NASDAQ:PYPL).
These stocks have outperformed the sector. They’re the future in a world of “social distancing” and increasingly online commerce. While they’re technically classified as technology stocks, I like them a lot better than the banks.
Big Tech has held up remarkably well. It’s the linchpin of the market but the stocks are not hurting in the same way as the banks or Big Oil.
Microsoft Corp. (NASDAQ:MSFT) and Apple Inc. (NASDAQ:AAPL) are the battleship stocks of the new economy. They aren’t going away any time soon. And Amazon.com Inc. (NASDAQ:AMZN) has recovered almost all the ground it lost early this month.
Think About Yield
Meanwhile, consumer patterns remain robust. But in a world of emergency grocery runs and home delivery, the landscape is changing.
I’ll be talking about this in more depth on my radio show. Are you listening? (Click here for recorded episodes and local stations.)
Start with delivery. Domino’s Pizza Inc. (NYSE:DPZ) is crushing more broad-based food delivery stocks like GrubHub Inc. (NASDAQ:GRUB), as well as Uber Technologies Inc. (NASDAQ:UBER), which also delivers from restaurants.
The outperformance isn’t hard to explain. UBER cars carry people, as well as food. Many of those people are sick right now, raising the risk that they’ll infect the drivers and the meals.
Nobody but the pizza driver ever gets into a Domino’s car. Which would you rather ask to bring the boxes to your door?
And as I mentioned last week, the real money is in online retail and the consumer brands themselves.
But if I had to pick a favorite theme, it would be the consumer brands. General Mills is shipping as much cereal as the factories can produce. And it pays close to 4% a year in dividends.
If Big Tech has become the new “mainstream” battleship of the market, Big Consumer stocks can play the role bonds play in the traditional investment portfolio.
Treasury bonds pay less than inflation. You’re not locking in any kind of income there. You’re guaranteeing the right to sacrifice purchasing power by the time you get your principal back.
General Mills is roughly as unlikely to default on its obligations as the Treasury at this point. Given that comparable risk profile, take the higher yield.
Johnson & Johnson (NYSE:JNJ) has a higher credit rating than the Treasury. It is less likely to default. And it pays 3% a year. Skip the bonds and load up on the stock instead.
Cannabis Corner: Bounce or Boom?
People are talking about a recession forcing more states to accelerate their cannabis legalization efforts. I don’t really see it happening yet, but it’s nice to see the stocks rebounding now.
My guess is that these stocks were simply oversold, and the short sellers are covering their positions. Whether that’s an illusion or a sign of real recovery remains to be seen.
We’ll play the recovery when it comes. As for the illusion, we can afford to remain patient before making any big move in this space.
After all, a stock like Tilray Inc. (NASDAQ:TLRY) can surge 140% from the depths like it did this week. But even with that bounce, it’s still down a harrowing 87% over the past 12 months.
When shareholders have accumulated that much pain, even the routine bounces can look astounding. We can say that about the market as a whole these days. Keep your powder dry and your eyes open.