Market action was mixed this week, leaving stocks little changed for the week. Early on, good news flowed as earning season began and progress continued on a potential new stimulus package. On Thursday, the tech sector came under pressure as this over-bought space encountered disappointing news on earnings and regulation. While investors in this area have enjoyed some quick returns lately, the pullback reminds us of the importance of diversification.
Don’t judge a book by its cover
The S&P 500 index is the most popular and widely used US stock index. Investors have flocked to this index to invest in a diversified mix of US large-cap companies, but a troubling pattern has emerged in recent days. As of June 30, 2020, the top five stocks now make up more than 22% of the index. This represents a greater concentration than during the tech bubble in the early 2000s.
What does this mean for your portfolio?
While on the surface, the S&P 500 has performed strongly since the lows of March 23, this index is providing less in the way of diversification. The top companies are all technology companies and are highly correlated: they often move in the same direction as each other. The recent outperformance by a select few companies could make the S&P 500 susceptible to a correction.
At W&H, we invest in the S&P 500 through two EFTs (exchange-traded funds):
- SPYG (SPDR Portfolios S&P 500 Growth ETF) – an ETF focusing on companies that offer strong earnings growth like technology and healthcare
- SPYV (SPDR Portfolios S&P 500 Value ETF) – an ETF focusing on companies that appear to be undervalued in the market like banks and energy companies
We diligently monitor your portfolio to ensure you have proper diversification. Asset classes such as US growth stocks, international stocks, small US stocks, and energy stocks have outperformed during the market rebound since March 23. To maintain adequate diversification, we rebalance some of the outperforming investments over time, using the proceeds to purchase lower-performing investments to lock in some of the gains.
If you’d like to learn more about how diversification impacts your portfolio, please let us know and we can have a more-detailed conversation.