Bridging the Gap(s): Converging and Diverging Trends Stemming From the Crisis

Key Points

  • A visual look at the K-shaped COVID era; including converging and diverging trends coming out of last year.

  • Broad shifts are underway within the stock market and economy, and the churning may take some time.

  • Excessive optimism across measures of sentiment hasn’t cooled, but strong breadth remains a tailwind.

In our 2021 outlook, we unveiled a visual highlighting the “K-shaped” nature of the COVID era, as seen below. In this report, we’ll share our thoughts on these divergences; including which are likely to persist, and which are already starting to converge. I’d like to give a shout-out to my research associate Kevin Gordon for his ample work on this analysis.

Source: Charles Schwab. Big 5 stocks and other 495 stocks represent members of the S&P 500. For illustrative purposes only.

The initial phase of the COVID crisis channeled aspects of many past calamities—the Great Depression in size, the stock market crash of 1987 in speed, and the 9-11 attacks in fear. With the benefit of hindsight, we know that some groups and industries were much better suited to handle that bitter combination; while others now face threats to their long-term survivability; thus resulting in the K-shaped nature of the recovery in which we find ourselves. As the economy began to reopen in some capacity last summer, we saw major splits between the haves and have-nots; pandemic winners and losers; and stay-at-home and get-out-and-about sectors. This report will look at what chasms have already started to close, those that are likely to converge sometime in the future, and those that may remain diverged.

Already (or soon to be) converging

We can start with gaps that are already starting to reverse. First up in the converging camp is large- and small-cap stocks. As you can see in the chart below, large caps fared much better during the initial plunge into bear market territory and subsequent rebound; while small caps didn’t erase their pandemic losses until November. Yet, the announcement of both Pfizer’s and Moderna’s vaccine effectiveness in early November gave small caps—along with other cyclical areas of the market—a significant boost as investors began to pull forward their expectations of a rebound in growth. As a reminder, we made the tactical recommendation on November 16th to “upgrade” small caps from underweight to neutral, and to “downgrade” large caps from overweight to neutral.

Small Caps Retake the Reins