If you just looked at the S&P 500, you would think November was an uneventful month as it was down less than 1%. However, the Russell 2000 and the MSCI international indices were all down more than 4%. In the bond market, prices on investment grade bonds rose some due to falling yields. Capital markets tightened with yields rising for riskier borrowers.
A look under the hood of the market at market internals is even more enlightening. The chart below is through 11/29/2021, and does not incorporate the continued sell off the market experienced over the last few days.
Our takeaway is that the vast majority of stocks are already in a correction, defined as a decline of 10% or more. Based on the last few days it seems safe to say that the average stock is already in a bear market, defined as a decline of 20% or more. With the major indices still holding onto healthy gains on the year, this may be surprising. Many investors are wondering what’s going on and how can this be?
Large cap US indices, like the S&P 500 and the more tech focused Nasdaq, have become more top heavy. The largest companies, all tech focused in one way or another, are comprising a larger and larger share of these indices. So far, these companies have held up, or even increased in value, as other constituents have declined. We think investors are increasingly hiding out in the largest of the large companies for the time being.
There are a variety of potential reasons for the recent volatility and concentrated strength. In our opinion, general volatility has come from two places: the prospect of Fed tapering its bond buying program sooner rather than later and the Omicron variant recently discovered in South Africa. We think some additional volatility is seasonal due to tax-loss selling and decreased risk appetite heading into year end. Anecdotally, we have observed that this seasonal effect looks most pronounced in companies that peaked earlier in the year.
We believe most of what is driving volatility and the disparity between the largest tech companies and the vast majority of companies is shorter-term in nature. We note that 2021 has a definitive end date on the horizon, and 2022 is a new year. The Fed’s plans are heavily caveated and subject to change. The Omicron variant complicates the picture further, but we expect to have a lot more clarity and information in the coming weeks. While this has been a challenging period in certain respects, and could remain so for some time, we remain focused on the long term.