Just last week, the S&P 500 Index pierced the 1900 level for the first time in history. However, some important divergences still exist in the stock market. For example, small-cap stocks, as represented by the Russell 2000 Index, are down approximately 5% year-to-date. In addition, technology stocks, as represented by the PowerShares QQQ ETF, are only up 1% year-to-date and are below their all-time highs. The S&P 500, which represents large-cap stocks, is up over 2.5% year-to-date. Thus, there has been significant variation in stocks returns across many equity benchmarks leaving investors confused by the volatile market action.
The heavy selling in technology and small-cap names over the past few months is indeed making some investors nervous. While divergences among market indexes typically can be a cause for concern, we believe the market has just been self-correcting the high valuations in some areas of the market. We are believers in the sustainability of the recent market highs set by the S&P 500. Indeed, since the beginning of the year, we have been pruning many of the higher valuation stocks in our Portfolios and replacing them with large-cap core and large-cap value stocks. We are of the belief that these types of stocks will continue to offer a superior risk/reward tradeoff versus the tech-heavy NASDAQ Index and small-cap stocks. It is all a matter of valuation and fundamental positioning. While the S&P 500 is not cheap, we do not find it expensive either given the backdrop of low interest rates and signs of an accelerating industrial economy.
We believe the importance of being in the right stocks is paramount right now. This is not a market that is driving all stocks higher. There are clear fundamental and valuation concerns within some pockets of the stock market. While we would clearly prefer to see more market breadth with all market averages setting all-time highs, we recognize it has become a stock-picker’s market. We have no shortage of stock selections offering attractive risk/reward tradeoffs. That being said, this is not the type of market where a dart board approach to stock selection is going to be effective as often occurs in many bull markets where a rising tide lifts all ships. It is not the time to believe that all stocks are going to participate in future market rallies. We anticipate wide disparities in the performance of individual stocks over the next few months. Now is the time to know what stocks you own and why you own it.