Beneath the Bonnet of the Biden Bounce

by Jeremy Benson

Last year, U.S. tech stocks carried on as if the global pandemic never occurred, with the tech-heavy Nasdaq 100 returning 48.9% for the calendar year compared to 18.4% for the S&P 500. With everyone locked inside, more money was spent shopping online (Amazon), purchasing new equipment for home offices (Microsoft), hosting work meetings online (Zoom), streaming movies (Netflix), and ordering food via services like Menulog and Uber Eats.

As the vaccine rollout progresses and much of the world starts to return to normal, the ‘Stay at home stocks’ that benefited most in 2020 are unlikely to do as well as the sectors that were hit hardest. In fact, from the start of 2021 to 11 June, the Nasdaq 100 was up just 7% compared to 18% for the equal weight S&P 500¹. Stocks like Zoom and Just Eat Takeaway (owner of Menulog) are well off their recent highs, while Netflix has traded in a sideways range for the best part of a year now.

The Biden bounce

Since the U.S. presidential election on 3 November 2020, the S&P 500 has staged a massive rally. Indeed, the gains from Election Day to Day 100 of Biden’s presidency marked the rally as the best performance for a new president since the 1930s when Franklin D. Roosevelt was elected.

It’s fair to say that plenty of American investors would be pretty happy with the market reaction to the election of President Biden (or perhaps the demise of Trump?). However, these returns should come as no surprise, given the well-publicised eye-watering fiscal stimulus plans of the Biden Government, and the impressive vaccine rollout seen in America.

Have you given equal weighting equal consideration?

Going one better, the S&P 500 Equal Weight Index has bounced even higher than the S&P 500 (market-cap weighted), returning about 35% from Election Day to 11 June 2021, and outperforming in six of the last seven months². It seems that some of our keener readers have indeed been giving equal weighting their consideration, as the BetaShares Equal Weight S&P 500 Index ETF (ASX: QUS) has tripled in size since adopting the equal weight strategy in December 2020³.

With the top five companies now accounting for over 20% of the S&P 500 – a level higher than the dot-com bubble and not seen in close to 50 years – the potential for continued outperformance from U.S. mega-cap tech companies could be limited as shown in the chart below.

Source: S&P Dow Jones Indices LLC. Chart shows cumulative relative returns for the S&P 500 Equal Weight Index versus the S&P 500, based on monthly total returns between December 1970 and December 2020. Cumulative weight of largest five S&P 500 companies based on month-end constituents. Past performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects hypothetical historical performance.

Why has equal weighting tended to outperform, and what has driven this performance?

As outlined in The Investment Case for QUS, indices based on equal weight have produced long-term outperformance relative to their market cap-weighted equivalents. In the case of the S&P 500 Equal Weight Index, the outperformance over the 20 years to 30 November 2020 was +2.17% p.a⁴. That said, over the shorter run, the equal weighted index has gone through periods of underperformance – as in the past three and five years – when larger cap stocks had periods of outperformance.

The investment factors behind the longer-term outperformance of equal weight strategies include:

• Size impact
• Increased diversification/lower concentration
• Rebalancing impact
• Stock return skew

Let’s look at a couple of these factors.

Size impact

As all 500 companies in the index are given a weighting of 0.2%, trillion dollar companies like Apple and Amazon are given the exact same weight as something like Campbell Soup (US$14 billion market cap). As a result, a fund like QUS has an overweight position in smaller companies relative to the S&P 500. This is important because empirical evidence shows that smaller companies have tended to outperform larger capitalisation stocks over the long run⁵.

As at 30 November 2020, of all the index factors, QUS was most overweight smaller companies, relative to the S&P 500. Source: S&P U.S. Equal Weight Sectors.

With the U.S. government giving stimulus payments to households, and lockdowns starting to end due to the vaccine rollout, smaller local U.S. businesses like shopping centres, restaurant chains, theme parks and toll roads could see a big boost in their earnings. As can be seen, this is exactly what has been happening to date, with smaller companies, as denoted by the S&P MidCap 400 Index, significantly outperforming the S&P 500 (market-cap weighted):

Source: Bloomberg. Past performance is not indicative of future performance.

Increased diversification/lower concentration

The S&P 500 Index’s five largest names were up significantly over the two years to 30 November 2020 (Microsoft +98%, Apple +173%, Amazon +87%, Facebook +97%, and Alphabet +61%). The weighted average return of the remaining stocks was only 24.9% over the same time period⁶.

With the potential for smaller companies to outperform the tech giants in an economic recovery, investors may want to consider limiting their exposure to this sector and focusing more on some of the sectors that were hardest hit last year – something that QUS can provide investors with compared to a standard S&P 500 market-cap weighted exposure.

The equal weight S&P 500 is underweight technology and overweight sectors that were hit hardest in 2020

As at 31 May 2021. Source: Bloomberg.

“S&P” and “S&P 500 Equal Weight” are registered trademarks of Standard & Poor’s Financial Services LLC (S&P) and have been licensed for use by BetaShares. QUS is not sponsored, endorsed, sold or promoted by S&P or its respective affiliates, and none of such parties make any representation regarding the advisability of investing in QUS nor do they have any liability for any errors, omissions or interruptions of the Index.

1. Source: Bloomberg.
2. Past performance is not indicative of future performance of any index or ETF. Index performance doesn’t take into account ETF fees and costs. You cannot invest directly in an index.
3. Note that QUS started using an equal weighting strategy on 18 December 2020. Prior to this date the Fund traded under a different investment strategy as the BetaShares FTSE RAFI U.S. 1000 ETF.
4. Source: Bloomberg, BetaShares. Past performance is not indicative of future performance of any index or ETF. Index performance doesn’t take into account ETF fees and costs. You cannot invest directly in an index.
5. Banz, R.W. (1981). “The Relationship between Return and Market Value of Common Stocks.” Journal of Financial Economics.
6. Source: BetaShares, Bloomberg. Returns in U.S. dollars.