Will Companies on Your Beat Sink or Swim in the Coming Months?

by July 8, 2020
Just because a given index seems to be doing well is no guarantee that all the component companies are doing similarly. Or all the sectors, for that matter. (Credit: Pixabay user 3844328)

The stock market is up! Oh, sorry, down! Ah, wait, up after all!

Trying to follow and explain what stocks are doing can be a challenge. Many of the explanations that experts offer boil down to their attempts for a simple connection between cause and effect. Fear of Covid-19 drives down the market one day and then the next, worries suddenly reduce and shares are back up again.

On the whole, we’ve seen a massive disconnection between stocks—which are really bets that investors place on what they think companies will be worth in the future—and the economy that most everyone lives with. Tens of millions are still out of work, states shutter themselves after inadequate measures to curb effects of the pandemic only see infections skyrocket, and business may be permanently changed.

But that is also deceptive and it comes down to the nature of how we understand and report the markets. The S&P 500, Nasdaq, Dow Jones Industrial Average, or even the Russell 2000 small- and mid-cap stocks are weighted indexes. More emphasis is placed on certain companies.

Some of the largest, most successful, and stable companies—those with the biggest market capitalizations—get outsized emphasis in the indexes. For example, in the S&P 500b at the end of June 2020, Microsoft and Apple each represented slightly more than 5 percent each of the index. The top ten stocks are 25% of the entire index.

In a similar sense, the 30 stocks in the Dow are averaged, so the more expensive shares have a larger impact on the final value. The Russell 2000 and Nasdaq are also market cap weighted.

In other words, just because a given index seems to be doing well is no guarantee that all the component companies are doing similarly. Or all the sectors, for that matter.

Data from S&P Capital IQ shows that the year-to-date (as of July 3, 2020) return on the S&P 500 health care sector is -0.3%. But compare that to materials (-6.2%), utilities (-10.4%), real estate (-8.0%), or energy (-37.9%). That’s a wild split on performance.

And then, within each sector, companies can demonstrate similar splits. One might be down while another is managing some positive return. The overall index will only confuse when trying for a better sense of how individual businesses, or even a particular sector, is doing.

The disparities open some interesting opportunities in reporting. Take a sector that you cover and look at how it has done in the indexes. Or put together your own list of corporations and compare their performance over any stretch of time. Then compare performance among competitors. And certainly watch individual companies over the next few months. Even if indexes seem to perform well, businesses you watch may not, or might even do better than average.