Finding Diamonds in the Rough

Treasure hunters seek out sunken shipwrecks, hidden gold, diamonds and pearls, as well as other lost riches in an attempt to achieve fame and fortune. The stories of Indiana Jones, The Goonies, and more recently, The Outer Banks (on Netflix) capture our heart and attention, as the underdogs seek to find hidden treasures. Before those treasures ever find their way onto an ill-fated galleon or buried in a tomb, most are first discovered by those willing to tirelessly dig, chisel and sift through some of the most hard-to-reach places on earth.  For those willing to put in the time and effort, finding treasures “in the rough” of the earth can be lucrative.

2020 has been a challenging year for most treasure-seeking investors. Through May 18, the stock market has been a lost expedition for many. The S&P 500 is down almost 9%, the Dow Industrials are down nearly 14%, the Russell 2000, which measures small-sized companies, is down over 20%. As we look across the globe, the All County World Index (ACWI) is down 11.6%, showing how widespread the selling has been in 2020 and how difficult it has been to find treasure.

Yet, a few diamonds remain in the rough. In the stock market, technology and health care stocks have been like valuable “gems.” The NASDAQ market, which focuses predominantly on technology and healthcare companies, is actually positive for the year (+0.47%). Technology companies are in high demand during a shutdown because workers need access to online software, fast networks, and mobile devices to work remotely. Additionally, during a health crisis, companies working on cures, medicine, and diagnostics are valuable during pandemics. These two areas have hit pay dirt.

Even as stocks sold off last week, the NASDAQ, dropped just 1% while the S&P 500 dropped 2.3% and the Dow fell 2.7%, showing that even during selloffs, health care and technology have been holding up better than other sectors. So far in 2020, most companies in positive territory for the year come from the technology and health care sectors. This trend will likely continue.  However, the companies with the best prospects for the future could change considerably in the days ahead.

Currently, the S&P 500 is dominated by five technology stocks—Alphabet/Google, Amazon, Apple, Facebook, and Microsoft, which are considered mighty “gems.” Because the S&P is market cap weighted, meaning larger companies have a larger voice, 20% of the index is heavily concentrated in these five companies. The aggregate market value of the FAAMG (Facebook, Amazon, Apple, Microsoft, Google) stocks is over $5.4 trillion.  Could a bubble have formed with so many treasure hunters chasing the same group of companies?

From the March 23 market bottom, all five of these stocks rebounded strongly. Despite the recent success for these five “gems,” we need to heed caution for the future. Hunting instead of mining  may be filled with a lot of pain, if history is our guide. Remember back in March 2000? Back then, seven technology companies accounted for 54% of the S&P 500. We all know what happened next: technology stocks cratered, and many fortunes were lost as those seven companies tumbled.

Just like in 2000, many bubbles will eventually burst. Many of those who were hunting treasures and not mining for them, ended up with fool’s gold. We’ve done our best to avoid hunting treasure and, instead, continue to dig, chisel and sift out valuable companies, ones you can be “proud to own.” Along the way, we have also come across other treasures that are in high demand areas, like cloud computing, animal medicine, cyber security, and information technology, to name a few. The stock market landscape should remain choppy for the foreseeable future, as long as COVID-19 remains a threat. It is a great time to continue sifting through the investment opportunities, looking for treasure among the rubble.

Sources: Yahoo Finance, Reuters.com, and JP Morgan Market Insights

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