What the Dow booting Exxon for tech really means to investors

Martin Pelletier: Don’t give in to your inner FOMO by chasing the current momentum in the so-called shift to the new world economy

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Last week, the Dow Jones announced a plan to remove the index’s longest-serving member — Exxon Mobil — in favour of three companies with a heavier tech focus, Salesforce, Amgen and Honeywell. We think this change is representative of something much bigger that is going on, a phenomenon that helps explain the perceived disconnect between the broader economy and the stock market.

When drilling deeper into recent gains in stock markets, it is clear that there have only been a few companies leading the way, while the majority of stocks are still lagging behind. Essentially investors have been plowing money into those companies that they think will benefit from the accelerated digital shift brought about by the pandemic, while selling old-school sectors such as energy and financials.

At more than US$6 trillion, the market capitalization of Apple, Amazon, Microsoft and Google is greater than the GDP of every country in the world with the exception of the U.S. and China

As a result consumer discretionary stocks (thanks to Amazon being 43 per cent of the index) and information technology stocks are up double-digits over their all-time February highs, while energy and financials are down significantly over the same period.

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Interestingly, nearly two-thirds of the companies in the S&P 500 are underperforming the index this year, only one-third of the stocks are positive this year with the share prices of a fifth of S&P companies currently more than 50 per cent below their all-time highs. This shift has been so pervasive that the five largest stocks in the S&P 500 have a combined market capitalization that equals the smallest 389 stocks in the index, according to Michael Batnick is the Director of Research at Ritholtz Wealth.

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At more than US$6 trillion, the market capitalization of Apple, Amazon, Microsoft and Google is greater than the GDP of every country in the world with the exception of the U.S. and China. Apple is setting new records with a price-to-earnings ratio of 35 times. Meanwhile, you now have a company like Tesla becoming the 9th-largest company in the U.S., even bigger than Walmart despite only having five per cent of the revenue.

Given the limited tech exposure elsewhere, international developed markets as represented by the MSCI EAFE index is still down seven per cent this year, and emerging markets are down approximately two per cent. Closer to home, the S&P TSX is down 1.7 per cent thanks to Shopify that is up nearly 165 per cent and now represents 6.5 per cent of the index.

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We think this could continue for some time as the saying goes markets can remain irrational longer than most can remain solvent — especially those trying to short this momentum. However, for the few contrarians left out there, opportunities remain especially should the broader economic recovery continue and old habits return.

For example, we’re already starting to see that in energy, and with global demand adding over 13 mmbbls/d over the past months returning it to 89 per cent of pre-pandemic levels. Eric Nuttall, portfolio manager at Nine Point Partners, pointed out on twitter that U.S. gasoline demand is down only five per cent from pre-pandemic levels.

The big question is how to play this going forward.

Being the risk-managers we are, we prefer more of a balanced approach as it offers some benefit from the ongoing tech rally but is also cautious due to the level of euphoria out there. This means owning a combination of the broader Canadian, EAFE and U.S. markets and for those who haven’t diversified, the good news is the Canadian dollar has recently been on a tear against the U.S. dollar making it that much less expensive. We also favour ETFs and stocks exhibiting lower levels of volatility such as what we’re seeing in the telecom, consumer staples, utilities and materials sectors.

Finally, make sure you don’t give in to your inner FOMO by chasing the current momentum in the so-called shift to the new world economy. This is when it’s important to have a well-laid-out gameplan focused on the long-term fundamentals and then stick to it.

Martin Pelletier, CFA, is a portfolio manager at Wellington-Altus Private Counsel Inc. (formerly TriVest Wealth Counsel Ltd.), a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax and estate planning.

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