The apocryphal Chinese curse that hopes for its victims to “live in interesting times” was visited upon all of us in the first half of 2020. A global public health crisis metastasized rapidly into an economic crisis, as nations and states intentionally constrained economic activity in an effort to slow down the spread of COVID-19. As economic activity ground to a halt in March, financial markets followed suit. From a peak on February 19, the S&P 500 fell 34% by March 23, erasing $13 trillion of market capitalization in a mere 23 trading sessions.

For a while it looked as if the economic crisis would cascade into a prolonged bear market, and some pundits were quick to label this a second Great Depression. Due to quick intervention by the Federal Reserve, however, and the willingness of investors to look beyond current headlines to the anticipation of recovery, financial markets recovered much of the first quarter’s losses in the second quarter.

Equity predominance through June 2020:  large cap stocks were negatively impacted less severally than small-cap, international and emerging market equities in 2020

The large-capitalization S&P 500 index ended the first half of 2020 down a mere 3.1%. As the nearby graph illustrates, returns for larger public companies have easily outpaced both smaller domestic stocks as well as international stocks over multiple time periods, and the first half of the year was no exception. Smaller stocks, as measured by the Russell 2000, fell 13.0% through the end of June, while developed international markets did a little better at -11.3% (measured in dollars). Emerging markets fell 9.8% over the same period.

The dominance of larger stocks has been persistent. Over the past year, large-cap returns are positive (7.5%), while other markets have lost value. The gap over longer time periods is stark, with the S&P 500 easily beating other measures of equity returns on an annualized basis over three-, five- and 10-year periods. Interestingly, the longer-term trend of large-cap dominance reversed in June. For the past month, emerging markets led the way, with the S&P 500 bringing up the rear. One month is not enough to establish a new trend, but this recent shift in market leadership warrants attention.

The U.S. markets are narrowly led. A small handful of technology names dominates the index composition, and the performance of these few companies has skewed the return of the index. Alphabet, Facebook, Apple, Microsoft and Amazon account for over 20% of the value of the S&P 500 and have handily beat the broad market so far this year. There is both good and bad news in this development. The bad news is that narrowly led markets tend to be fragile and volatile. A misstep by any one of these companies, or a simple shift in investor sentiment, could bring the index down sharply. The good news is that, although the index is within a few percentage points of a new all-time high, the average stock is not. There are plenty of opportunities in companies that have not participated in the tech-led rally of the past three months.

The narrow path of market leadership, 2020 returns: IT companies made up the majority of the S&P’s positive returns (amazon 49.3%)

This leadership is reflected in sector performance. Information technology is one of only two sectors (the other being consumer discretionary) that has posted positive returns this year, and has provided an annualized return of 26.8% over the past three years. Four sectors beat the broad market in the first half, with seven posting worse relative performance. To generalize from this data, parts of the market with exposure to decent personal consumption patterns (consumer discretionary), medical spending (healthcare) and remote working (technology and telecommunications) held up well. Market sectors with more economic or financial sensitivity (materials, real estate, industrials, financials and energy) lagged the index.

Equity sector performance through June 2020: IT at 15% YTD (top) and Energy at -35.5% YTD (bottom)

As July unfolds and companies report earnings for the second quarter, we will learn more about the damage wrought by COVID-19 on companies’ profits, and, more importantly, what management expectations are for the balance of the year. Many companies have understandably suspended earnings guidance, given the unprecedented nature of the shutdown and the uncertain path to economic recovery. Indeed, as cases of COVID-19 surge in some parts of the country, companies are unlikely to make any forward-looking statements with confidence.

Consensus expectations call for a 44% year-over-year decline in second quarter S&P 500 earnings, but a slight increase from the first quarter. This seems optimistic to us, as the real economic damage did not begin until late in the first quarter, and then extended throughout most of the second quarter. It is more likely that the second quarter will mark the bottom in this cycle, with a rebound dependent on the path and pace of economic recovery.

And therein lies the biggest risk for the second half of the year. The economic crisis is a direct result of a public healthcare crisis that shows no real signs of abating, at least on a national level. Unless or until we succeed in controlling the spread of COVID-19, either through the development of a vaccine, or better treatments and patient outcomes, or stricter adherence to social behavior, the volatility of the first half of 2020 could easily return.

Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice. References to specific securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations. Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally.  This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented.  This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2020. All rights reserved. PB-03776-2020-07-01