The S&P isn't everything

But it's a lot

Right now, the S&P 500 represents approximately $34 trillion in total market capitalization. That’s a lot of money. But, it’s still just a subset of the total U.S. equity market:

And, if you think that those dollar figures are just too high and there should be another downturn in the stock market because it’s disconnected from the economy…well, GDP looks like it will grow faster than expected when 2020Q4 results come out:

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COVID-19’s Effect on S&P 500 Profitability

An analysis using return on assets

A classic profitability metric is return on assets (“ROA”), which simply divides net income by average total assets. This ratio allows us to easily compare companies of different sizes using a standardized approach to assess the volatility of earnings against the more stable behavior of assets on the balance sheet.

Analyzing the most recent complete set of quarterly filings from 2019Q4 to 2020Q3 and the year prior (2018Q4 to 2019Q3) for companies currently in the S&P 500, we get the following:

What we see in the scatter plot is that most companies that were profitable prior to COVID continued to be profitable during COVID. There was, however, a noticeable effect from the pandemic in terms of depressed earnings. On average, companies saw their ROA decrease to about 75% of levels seen in the year before the pandemic.

While there was an impact, it really wasn’t that big of one. Further, it’s unlikely that we will see another shock on the market from a subsequent infection wave as big as the first wave. Thus, we should expect profitability to continue to improve as time passes.

In this simple context then, the stock market may not be as frothy as it appears. The worst should be behind us and companies really didn’t even take that big of a hit. It’s a surprise, given the economic backdrop, but the market isn’t as concerned with the economy if companies keep making money. And, this crazy rally since March seems to confirm not only that but also optimism for the future - whether prudent or not.

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Retail Sales and Industrial Production

Two sides of the economy are telling different stories

After an unprecedented drop in retail sales earlier this year, the pandemic showed us that the American drive to purchase things is mightier than any deadly virus:

While retail has cooled somewhat recently, it remains near long-term average levels. Industrial production, however, is still well off the pre-pandemic normal:

Capacity utilization offers another look at production and shows us what portion of total available production capacity is in use. It’s not looking too great either:

The good news is that industrial production is a small part of the overall economy. Consumption is about 70%. So, you would much rather have strong retail sales and weak production than the other way around. What will be intriguing from here is whether the strong shopper can continue to hang on and avoid a post-holiday hangover.

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Investing $2,500 - Round 2

Tech and things

Yesterday was the second purchasing round of the 2021 investment schedule. I’ll first cover the positions and then go through a bit of the thought process behind it.

Main Fund Purchases

#. Company / Stock Name (Ticker) - $ Amount | $ Cost Basis / Share

  1. Apple (AAPL) - $600 | $129.70

  2. Microsoft (MSFT) - $600 | $213.65

  3. Intuit (INTU) - $600 | $367.00

  4. SVB Financial (SIVB) - $300 | $457.69

  5. Target (TGT) - $300 | $197.50

  6. iShares 7-10 Year Treasury Bond ETF (IEF) - $50 | $118.25

  7. iShares Gold Trust (IAU) - $50 | $17.55

  8. Residual Cash - $0

Some Qualitative Thoughts

I loaded up on tech here. Apple, Microsoft, and Intuit have strong fundamentals and have historically outperformed the S&P. I think that will continue. And, I will need that additional lift as my round one purchases two weeks ago were relatively conservative.

Tech’s performance has been pretty muted this year and all three of these stocks are sitting off their recent highs. If it was a few months ago, I would’ve been more interested in other sectors like energy and financials but those have had a really strong start to the year, so, overall, it seemed like a good chance to pick up these solid names.

For Target and SVB, these are two picks that I’m kicking myself for not purchasing in the first buying round. They were the first two names that didn’t make the cut and both have ripped much higher than the stocks I actually bought. I’m cautious given their outperformance, so I only went $300 on each. If they pull back from their recent run, I’ll be happy to pick up more shares.

As gold and bonds have underperformed since the start of the year, I grabbed a little more than last time and decided not to float any cash. I could’ve gone either way with buying less and holding cash but it’s a small allocation, so I didn’t overthink it.

The biggest disappointment this round came from my timing. Futures were red prior to the market open and, when the market instead rallied in the first few minutes, I placed most of my orders out of concern that the market would continue to rise and force me to chase on price. Not long after I placed orders and got fills, the market dropped around 1% and I missed a really easy set of lower entry points. Despite that, the positions still ended the day better off than the market as a whole.

On a final note, I was quite on the fence about whether or not to jump into energy, since it had such a strong start to the year. I’ll continue to monitor the sector but, right now, I don’t want to overpay for stocks with much weaker fundamentals than what I could get elsewhere just because of a fear of missing out. In the short term, seeing energy take a big hit today felt like a small amount of validation.

Overall, I’m feeling good in the decisions for both rounds thus far. It’ll definitely be interesting to see how these moves pan out in the coming weeks and months.

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