May 24, 2020

Reconciling Wall Street and Main Street

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The Bottom Line:


The relative strength of the S&P 500 (SPY) compared with the dramatic weakness in the US economy seems irrational.  This stems from faulty comparisons.  Technology and healthcare stocks now account for 40% of the S&P 500 and many, arguably, benefit from COVID.  The real economic damage resides within other industries, and predominately within smaller companies.  Fortunately, Standard and Poor’s has an index for them too…the S&P 600 Pure Value Index (RZV).  This index more directly represents Main Street reality and sits 40% lower on the year.  However, this week, rolling re-openings and promising vaccine data lifted this index 10% compared with a 3% rise for S&P 500.  For those looking to use the stock market as a harbinger of progress, it’s time to turn the binoculars around and focus on the RZV and not the SPY.  It will certainly make more sense, and when we turn the corner on the economy, you will really like what you see!


The Full Story:


Someone asked me last month which indicator I would choose for orientation during the COVID crisis if I could choose just one.  That’s tough.  Candidates could include daily case rates, daily fatalities, the RO (R naught), the unemployment rate, the Dow, the US dollar, Treasury yields, Trump’s reelection odds or perhaps even gold.  In selecting just one proxy indicator, I would need one that captures all the inputs, including health developments, central banking policies, fiscal policies, and economic direction.  I’d also need one that’s easy to track and updates in real time.  Let’s begin with the past.  In the Great Recession, the banks were ground zero.  For any recovery to gain credibility, the bank stocks needed to bottom.  From the top, the S&P 500 Banking Index fell 85% between February of 2007 and March of 2009.  Over the next two months, these same stocks rallied 165%, sounding the all clear.  In the COVID crisis, small businesses are ground zero.  Small businesses typically have lower margins, fewer financing options and less experienced leadership than large businesses.  In a storm, it’s the S.S. Minnow that gets tossed about, not the U.S.S. Intrepid, and COVID is a class 5.  How will we know when the storm has really passed?  When the Minnows in our economy retake cruising speed.


While I recognize the marketplace obsession with the S&P 500 index, Standard and Poor’s actually tracks over 1,800 different stock market indices surveying every imaginable cohort.  The companies within the S&P 500 Index represent only the largest US companies, many of which have benefitted from COVID.  In fact, some of the largest beneficiaries, Microsoft, Apple, Amazon, Google and Facebook account for more than 20% of the entire index:


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This explains the disconnect between the drawdown in the “economy” and the resilience of the “stock market”.  The S&P 500 cap-weighted index communicates more about the health of big-cap tech than about the economy overall.  To correct for these size distortions and better calibrate the “stock market” with the “economy”, an equal weight version of the S&P 500 exists.  While the S&P 500 cap-weighted index has fallen a mere 9% this year, the S&P 500 equal weight index has shed a more COVID-like 17%.  But even still, these larger “Wall Street” companies should have more in their survival kits than their smaller “Main Street” peers, suggesting more damage below.


The S&P 600 Small Cap Index contains 600 companies with market caps between around $500 million and $2 billion and has fallen 24% year to date.  Recognizing that COVID has also benefitted some small stay-at-home technology and health care companies, locating a small-cap non-tech, non-healthcare index would provide the purest real time read on main-street conditions.  Fortunately, Standard and Poor’s has an index for everything!  The S&P Small Cap 600 Pure Value Index consists of 146 companies operating primarily within consumer, industrial, energy and financial sectors.  At its lowest point during the COVID panic, this more pedestrian, main-street index, fell 56%.  That’s not quite as dire as the 85% drawdown by the banks during the Great Recession, but the speedy relief efforts from the Fed and Congress likely forestalled larger declines.  For most of the rally from the March lows, this index has underperformed large-cap technology-heavy comparisons, but has caught wind as of late.  Over the last week, the S&P Small Cap Pure Value Index (Ticker: RZV) returned 10% while the S&P 500 (Ticker: SPY) returned slightly more than 3%.  For the trailing month, this main-street index has rallied 17% compared with 6% for the S&P 500.  Will the trend continue?  Unclear.  But a rally in the most vulnerable small companies does meet the prescription for recovery and offers much more meaningful information on our COVID progress than movements in the S&P 500.  If I could have only one indicator to assess the COVID crises…I’d take the RZV.


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Have a great Memorial Day weekend!



David S. Waddell 
CEO, Chief Investment Strategist



David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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