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The S&P dropped 33.9% in just 23 trading days in Q1 2020. Thereafter, public equity markets staged a phenomenal rebound as the S&P 500, the Dow Jones Industrial Average and the NASDAQ Composite reached all-time highs by year end, driven primarily by growth and technology stocks. The tech-heavy NASDAQ rose 87.9% since its March lows. Meanwhile, the broader S&P 500 and the Dow Jones Industrial Average increased 67.9% and 64.6% over the same period, as some investors considered the business models of blue-chip banks, energy producers, retailers, etc., less defensive in the post-COVID-19 world.

Post-COVID Market Drivers

The most popular stocks have been technology names. The earnings growth of Facebook, Amazon, Apple, Netflix, Google parent Alphabet, and Microsoft was accelerated by COVID-19 restrictions, which heightened the need for phones, computers, and digital services and applications. These six stocks comprised almost 25% of the S&P 500 market capitalization and 77% of the gains in the index during the last 12 months (LTM) of September 2020.

Several factors contributed to the disparity between the performance of large-cap technology stocks and the rest of the market. Most notably, the lockdowns accelerated growth trends that were already underway. The digital transformation of economies was rushed when consumers were suddenly confined to their homes, and large-cap tech companies were ready to support their at-home activities and lifestyles.  Outside the formal technology sector, the shares of Tesla increased over 700% in 2020 as investors anticipated a faster transition to renewable energy sources following the COVID-induced turmoil in oil markets.

Narrowing Disparity in Performance

The relative outperformance of large technology stocks over small companies so far this cycle may be narrowing. Since reports of COVID-19 vaccine approvals in early November, small stocks and value names have started catching up with growth stocks, with the Russell 2000 Index (Ticker: RUT) rising nearly 30% between October end and year end.

Financials, a classic example of value stocks that feature strong balance sheets and consistent dividends, lagged the broader market significantly as rates dropped sharply across the yield curve in response to the pandemic while the prospect of higher credit losses loomed following the downturn. In the last two months of 2020, however, the Financial Select Sector SPDR ETF (Ticker: XLF) rose 23.6% as vaccine news revived small business borrowing, outpacing the 18% gain of the NASDAQ over the same period.

The KBW Bank Index, a composite of 24 US banks, rallied 35% in Q4 2020.  As mentioned in the article posted in late October, US banks have the highest capital levels in 80 years and, unlike their European and Japanese counterparts, their net interest margins have remained resilient around 2.50% over decades, including when short-term rates were zero emerging from the 2008-2009 financial crisis. In Q3 2020, the sector was meaningfully under-owned compared to any time in the past decade. Additionally, government support helped bridge borrowers through the pandemic, and more support came with the new stimulus package just passed in Washington.  Banks reemerged as an attractive segment with optimism for an economic recovery and further upside if the yield curve expands.