Indexology^® Blog

Explore the headwinds and tailwinds facing insurers and how these factors are impacting general accounts portfolios.

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The headline S&P GSCI fell 3.6% in October. Energy was responsible for the bulk of the declines in October, while agriculture continued to benefit from the return of demand from China, as well as weather-related supply issues.

Across the energy complex, the rising number of COVID-19 infections, a second wave of lockdowns, and travel restrictions presented a serious threat to oil demand. The S&P GSCI Petroleum fell 10.9% in October, reflecting the risk of a sizeable amount of demand destruction over the coming months. Global oil inventories have remained well above their five-year average, consumption has recovered more slowly than expected, and a resurgent COVID-19 pandemic threatens a double-dip recession. The OPEC+ group is scheduled to hold a policy meeting at the end of November and must decide whether to delay plans to ramp up output by 2 million barrels per day, starting in January 2021, in light of the poor demand picture.

The importance of China’s role in industrial metals was once again on display in October. In contrast to energy, the S&P GSCI Industrial Metals ended the month up 2.8%. According to many market participants, the old era of aluminum, characterized by seemingly immeasurable Chinese smelter capacity expansion, multi-year surpluses, and high inventories, may finally be coming to an end. The S&P GSCI Aluminum ended the month up 5.3%. Nickel also rallied; the S&P GSCI Nickel ended the month 4.3% higher, based on ore shortages and robust demand from China’s stainless-steel mills.

The performance across precious metals was lackluster in October, despite a clear decline in risk appetite among investors resulting from the long-term fiscal and monetary implications of the global pandemic and uncertainty over the outcome of the U.S. presidential election. The S&P GSCI Gold ended the month down marginally but remained up 20.4% YTD.

The S&P GSCI Grains rose 4.3% on the month and its YTD performance turned positive. After a bearish situation surrounding prices over the summer, recent supply issues and a pickup in demand benefitted corn, soybeans, and wheat. Within the softs space, cotton and sugar rose during the month while coffee and cocoa fell. The S&P GSCI Cocoa moved the most, falling 9.9% on the month. A big drop in demand due to the pandemic left the world’s largest cocoa producer, Ivory Coast, struggling to sell 500,000 tons of cocoa beans from its interim harvest.

A recovery in demand from China continued to support hog prices in October; the S&P GSCI Lean Hogs was up 3.9% over the month. However, the cattle market struggled under the weight of heavy supplies, concern regarding demand from the U.S. foodservice sector, and uncertainty surrounding consumers’ food purchasing behavior over the holiday period in light of the pandemic. The S&P GSCI Live Cattle was down 3.6% in October.

While the types of businesses most prominent in the market vary through time, the fact that a small subset of companies’ stocks account for an outsized portion of the stock market is not new. Moreover, research suggests these stocks’ best performance might be in the rearview mirror. The takeaway is that relying on well-established investing principles such as broad diversification helps ensure investors have exposure to a vast array of companies and sectors, potentially providing a more reliable approach to achieving their investment goals.

History Repeats

In 1967, the largest 10 stocks accounted for over 20% of market capitalization, and a marquee technology firm, IBM, was perched at No. 1. This sounds like a description of the current US stock market, dominated by Apple and the other FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google, a subsidiary of Alphabet). Back then, however, IBM represented a larger portion of the market than Apple at the end of 2019 (5.8% vs. 4.1%).

As we see in Exhibit 1, it is not particularly unusual for the market to be concentrated in a handful of stocks. The combined market capitalization weight of the 10 largest stocks, just over 20% at the end of last year, has been higher in the past.

A breakdown of the largest US stocks by decade shows some companies have stayed on top for a long time (see Exhibit 2). AT&T was among the largest two for six straight decades beginning in 1930. General Motors and General Electric ranked in the top 10 at the start of multiple decades. IBM and Exxon were also mainstays in the second half of the 20th century. Hence, concentration of the stock market in a few large companies such as the FAANG stocks in recent years is not a new normal; it is an old normal.

Moreover, while the definition of “high-tech” is constantly evolving, firms dominating the market have often been on the cutting edge of technology. AT&T offered the first mobile telephone service in 1946. General Motors pioneered such innovations as the electric car starter, airbags, and the automatic transmission. General Electric built upon the original Edison light bulb invention, contributing to further breakthroughs in lighting technology, such as the fluorescent bulb, halogen bulb, and the LED. So technological innovation dominating the stock market is not a new normal; it is an old normal too.

Another trend attributed to a new normal is the extraordinary performance of FAANG stocks over the past decade, leading some to wonder if we should expect these stocks to continue such strong performance going forward. Investors should remember that any expectations about the future operational performance of a firm are typically already reflected in its current price. While positive developments for the company that exceed current expectations may lead to further appreciation of its stock price, those unexpected changes are not predictable.

To this point, charting the performance of stocks following the year they joined the list of the 10 largest firms shows decidedly lower performance  results (see Exhibit 3). On average, these stocks outperformed the market by an annualized 0.7% in the subsequent three-year period. Over five- and 10-year periods, these stocks underperformed the market on average.

The only constant is change, and the more things change the more they stay the same. This seems an apt description of the dominant stocks atop the market. For investors, the implications may be that (1) a stock market concentrated in handful of stocks is not necessarily a reason to reevaluate one’s investment approach and (2) the lackluster performance of stocks after they reach the top of the market serves as a reminder of the importance of broad diversification.

DISCLOSURES:

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.

There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Only a few months ago, it seemed that global soybean supplies were more than ample, and in the case of the U.S., a semi-permanent soybean mountain had been built in the wake of damaged demand from its top customer, China. Fast forward to late October 2020, and the S&P GSCI Soybeans is up 29% since the low in March of this year, making a new high last week driven by abrupt supply cuts and the rapid return of export demand. Earlier this month, the USDA’s monthly World Agricultural Supply and Demand Estimates (WASDE) report forecast a large, and somewhat unexpected, reduction in global soybean stocks. Exhibit 1 illustrates global soybean ending stocks in the 2020-2021 crop year dropping in October 2020 to the lowest level in four years.

Brazil and the U.S. make up approximately 85% of total soybean exports, and there have been supply issues in both countries. There has been limited availability of exportable supplies in Brazil due to COVID-19, and now there is an increased possibility of South American supplies tightening in 2021, particularly if the current La Niña weather pattern leads to drier conditions in Brazil and Argentina. Similarly, in the U.S., dry conditions have negatively affected yields.

On the demand side of the ledger, China imports roughly 60% of total global soybean exports. The recovery of China’s pork industry from the African swine fever has spurred imports in 2020. Soybean meal is used as a source of feedstock in animal production. Chinese monthly imports of soybeans reached a new five-year high this Northern Hemisphere summer (see Exhibit 2).

According to the USDA, outstanding sales to China from the U.S. in mid-September 2020 totaled nearly 17.0 million metric tons, nearly equal to the record set in 2013. Total outstanding sales for all markets in mid-September 2020 were at a record 32.0 million metric tons, a three-fold increase compared with those in 2019. The 2018-2019 crop year coincided with the start of the China-U.S. trade war, which was the catalyst for U.S. soybean exports to plummet. Two years later, China’s commitment has rebounded substantially.

The S&P GSCI Soybeans is designed to provide investors with a reliable and publicly available benchmark for investment performance in the soybean market. S&P Dow Jones Indices offers different versions of this index to cater to the needs of market participants. These versions include enhanced roll yields, dynamic roll yields, covered calls, forwards, 2x leveraged, and currency and regional indices. Single-commodity indices can offer investors an efficient way to access the return streams of unique assets such as soybeans.

In Q3 2020, we saw a continuation of the technology-led global equity market rebound with the S&P 500^® up 8.9%, the S&P Europe 350^® up 4.3%, and the S&P Pan Asia BMI up 8.9%, while the S&P Developed Ex-U.S. BMI and the S&P Emerging BMI were up 6.3% and 9.0%, respectively. The story was different in Latin America, where the equity market has little exposure to technology-driven companies, though some markets benefited from the boom in mining stocks.

Overall, Latin American equities remained flat (-0.2%) in USD terms, as measured by the S&P Latin America BMI, a broad, regional index designed to measure the performance of 289 stocks from Brazil, Chile, Colombia, Mexico, and Peru.  However, the S&P Latin America 40, representing the 40 largest (by market cap) and most liquid stocks, dropped a full 2.0% for the quarter amid the continued ravaging of COVID-19 on public health and the local economy.

On the economic front, S&P Global Ratings’ analysts recently reported¹ that Latin America is in the middle of a recovery. However, the 2020 GDP forecast for all countries in the region will remain contracted. Due to strong exports to China and less stringent lockdowns, Brazil’s economic contraction will be less severe than was originally forecasted, while other countries like Argentina, Colombia, Mexico, and Peru will be worse off than expected. Meanwhile, Chile is very much on target. Many variables will affect the depth and speed of the recovery as countries try to emerge from the worst pandemic in more than 100 years.

At the sector level, Information Technology, Materials, and Industrials were the winners, with positive returns of 19.1%, 15.2%, and 8.3%, respectively for Q3 2020. The worst performers were Energy, Utilities, and Financials, losing 9.1%, 6.8%, and 6.4%, respectively.

Argentina’s economy is one of the most affected in the region, but economists expect Q3 2020 to be the start of its gradual stabilization.² S&P Global Ratings has raised the country’s rating based on a new proposal to restructure its debt in order to avoid another sovereign default. The S&P MERVAL Index gained 7% in ARS for the quarter, with the S&P/BYMA Argentina General Construction Index leading the sector board (up 42.5%); the biggest losses came from the Energy sector (-8.9%).

Brazil’s equity market was nearly flat, with the Brazil 100 Index (IBrX 100) and the S&P Brazil BMI gaining 0.0% and 0.7%, respectively. This may be a first step in the right direction, with the economy³ rebounding during Q3, primarily driven by increased demand in commodity and food exports. Not surprisingly, the S&P/B3 Momentum Index (up 8.5%) and the S&P/B3 High Beta Index (up 5.9%) did well. These smart beta indices are designed to measure stock performance while factoring in the sensitivity of the market and its movements. Likewise, the S&P/B3 Ingenius Index (up 21.0%) continued to generate extraordinary returns in the midst of the pandemic, benefiting from the performance of technology-driven stocks.

Chile is not only struggling with the pandemic, but it is also in the middle of a major potential political change, with an upcoming referendum for a new constitution. All this uncertainty is keeping the equity market in the red, with the S&P IPSA dropping 8.1% in Q3. S&P Global Rating’s economists, however, have been more optimistic about a quick economic recovery in Chile, given the “strong government support for labor markets and business.” Chile’s shining spot was in the mining sector, with the S&P/CLX Natural Resources Index gaining 9.6% in Q3.

Colombia and Peru generated strong results. The S&P Colombia Select Index gained 7.3% for the quarter. Among Peruvian equity indices, the S&P/BVL Peru Select 20% Capped Index was the best performer (up 9.3% in PEN and 7.4% in USD) for Q3, aided by the high returns of the mining sector, as the S&P/BVL Mining Index had double digit returns (up 20.6% in PEN and 18.5% in USD).

Mexico’s main equity indices were generally flat, with the S&P/BMV IPC losing 0.7% for Q3. The exception was the S&P/BMV IRT MidCap, which gained 10.1% for the same period. Looking at the sector indices, the story of Chile and Peru repeats itself, with the mining sector in Mexico yielding the highest return, with the S&P/BMV Materials Select Sector Index gaining 17.3%. Among other industries, FIBRAs in Mexico had a strong third quarter, with returns of 5.9%. As was the case in Brazil with the S&P/B3 Ingenius Index, the S&P/BMV Ingenius Index gained 12.0% for the quarter and 56.6% YTD.

It has been a long year and the end cannot come soon enough. As we enter the last quarter of 2020, let us hope for a speedy and strong recovery for Latin American economies, equity markets, and its people.

For more information on how Latin American benchmarks performed in Q3 2020, read our latest Latin America Scorecard.

¹   Elijah Oliveros-Rosen, Latin America Senior Economist. Economic Research: Latin America’s Pre-COVID-19 Growth Challenges Won’t Go Away Post-Pandemic. Sept. 24, 2020. S&P Global Ratings.

²   FocusEconomics: Argentina Economic Outlook. Sept. 15, 2020. www.focus-economics.com.

³   FocusEconomics: Brazil Economic Outlook. Sept. 15, 2020. www.focus-economics.com.