COVID-era "K-Train" heads in different directions for haves, have-nots

Mr. Kim is the Chief Operation Officer and Chief Compliance Officer for Kirr
Marbach & Co. LLC, an investment adviser based in Columbus IN. Please visit
www.kirrmar.com <www.kirrmar.com> .

Who can ever forget the Muppets’
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“Alphabet Song” on Sesame Street? “B” is for Bert. “C” is for Cookie
Monster. Certainly not Wall Street pundits, who debated which letter would
best describe the path of the eventual post-COVID recovery.

Would it be a “V” (sharp decline-sharp rebound), “W,” “U,”
“L,” or even a “Nike Swoosh?”

The letter “K” is a vertical line with two 45-degree lines
slanting from the middle, one upward and one downward, and unfortunately
best describes the paths of the economy and stock market since the nadir
(hopefully) of the COVID pandemic in March. The gap between the “haves” and
“have-nots” has further widened over the intervening six months, resulting
in the “haves” having more (sometimes much more) and the “have nots” having
less (oftentimes much less).

The “happy,” upward-slanting line symbolizes those parts of
the economy that actually benefitted from the pandemic.

Technology companies like Apple and Zoom gained from the massive,
instantaneous switch to “work from home (WFH).” Netflix kept us
entertained. Target and Walmart sold copious amounts of household staples.
Home Depot and Lowe’s gained as folks decided to fix-up their homes. Amazon
continued to grab market share from bricks and mortar competitors.

Not surprisingly, the Direxion Work From Home ETF (Ticker: WFH) was recently
launched to make it easy for the Robinhood crowd to jump on the bandwagon
with a single click.

The “sad,” downward-slanting line symbolizes pretty much everything else.

The list of companies hurt by the pandemic is much longer and contains a
boatload of bankruptcies, with more sure to come. For retailers that were
already teetering like J.C. Penney, Pier One and Brooks Brothers, the
pandemic was just the final straw. Any business dependent on physical
customers, like airlines, hotels and restaurants, is facing a genuine
existential crisis.

The situation is even more dire for small, privately-held businesses, which
employ the majority of Americans. Yelp reported that as of the end of
August, 163,735 businesses indicated they were closed, up 23% from July.
Further, the National Restaurant Association said at least 100,000
restaurants are closed (nearly one in six) and three million restaurant
employees are without a job. Alarmingly, with cold weather approaching, 40%
of owners surveyed said they are likely to close within six months without
additional government support.

On February 19, the S&P 500 reached a record high. As the government
effectively shut down the economy in an attempt to contain the pandemic,
panic ensued, with the S&P 500 plunging 34% over the next five weeks.
Incredibly, by September 2 the S&P 500 made a new record high, as investors
seemingly put COVID in the rearview mirror.

How can you reconcile the disconnect between the joy on Wall Street and the
continuing pain on Main Street?

First, there is an old investing adage, “don’t fight the Fed,” which means
if the Federal Reserve wants to support stocks with lower interest rates
(like now), stock prices are unlikely to act contrary.

Second, the lower the interest rate, the higher the multiple of earnings
investors are willing to pay, resulting in higher stock prices. Further,
with bond yields approaching zero, investors are facing the reality of TINA,
or There is No Alternative (to stocks). The Fed is forcing investors into
riskier assets.

Third, this is one of those times the S&P 500 is a terrible proxy for the
performance of the “average” stock. The S&P 500 is a
capitalization-weighted index, which means the performance of the
largest-capitalization (i.e. stock price times number of shares outstanding)
stocks impact index returns much more than the smaller-capitalization
stocks.

For instance, Apple recently became the first U.S. company to attain a
market capitalization of $2 trillion, more than the total market
capitalization of the entire Russell 2000 small-capitalization index.
Indeed, the “Fab-Five” largest-capitalization stocks in the S&P 500 (i.e. 1%
of the stocks)-Apple (up 76% year-to-date (YTD) through August), Amazon
(87%), Microsoft (43%), Google parent Alphabet (22%) and Facebook
(43%)-recently had a combined index weight of 23%, the highest concentration
in 30 years.

Indeed, while the S&P 500 had a total return of 9.7% YTD through August, the
version of the S&P 500 that gives an equal 0.2% weight to each of the 500
stocks had a total return of minus 2.3%. Clearly, the massive gains in the
mega-capitalization technology stocks have masked weakness in low-index
weight sectors that have been decimated, like Energy (2.3% weight-down 40%),
which simply don’t register.

The opinions expressed in these articles are those of the author as of the
date the article was published. These opinions have not been updated or
supplemented and may not reflect the author’s views today. The information
provided in these articles does not provide information reasonably
sufficient upon which to base an investment decision and should not be
considered a recommendation to purchase or sell any particular stock or
other investment.