Investing in the Index Does Not Cut It
It has been 66 days since stocks bottomed on March 23rd and US equities have posted positive returns. The S&P 500 is up 35.4% through Thursday’s market close, while the Dow Jones Industrial increased 36.6% and the tech heavy NASDAQ Composite is up 36.5%. However, the broader indexes are still down year-to-date, except for the NASDAQ, which is now in positive territory.
We have been saying for quite some time now that investing in the broad index is no longer a sound approach. When an investor purchases shares in an ETF or mutual fund that tracks an index, they are buying exposure to all the companies in the index. That means investing in great, good, and bad companies without discriminating which stocks have higher potential and which stocks do not make sense in the current environment.
Since COVID-19 shocked the markets, it provided a greater reason why individual security selection is a superior approach. When we observe market dislocation, volatility picks up and we get market swings on the downside and upside as the market attempts to find its way back to equilibrium. This process provides opportunities to find great companies that have been unjustifiably sold off more than their fundamentals warrant, which then leads to big returns in the short run.
The S&P 500 hit its all-time high on February 19th, 2020 and sold off by 33.9% when it bottomed in March. However, some stocks were punished by a much greater amount. For example, RH, an upscale furniture company, sold off 67.8% during that same period. The thought was people would not purchase furniture during the COVID-19 scare. Although that might be a sound thesis, if the stock price has been brought down more than the anticipated loss in cashflow by the company, the stock has been sold off more than their fundamentals warrant. This provides an opportunity when the situation is analyzed carefully. Fast forward 66 days after the March lows and now RH is up 161.4%. We were able to take advantage of the selloff in RH and purchased the stock while it was still down. We closed our position this week and realized great returns for our clients. Of course, at the time we did not know when the market would bottom, so we waited to see some positive momentum before entering the trade. Nevertheless, the returns were substantial over the course of several weeks.
Coming back to investing in an index vs investing in individual securities, had an investor decided to purchase the Consumer Discretionary Index or the Retail Index (RH is a subset of both), the returns would have been very different. Over the last 66 days, the Consumer Discretionary Index returned 39.5%, while the Retail Index returned 36.7%.
Not every market environment will provide these types of opportunities, but when they appear, great returns can be generated. The Surevest Investment Committee continues to analyze the environment and when we find opportunities, we will seize the moment.