401(k)s might be hurt short-term by the economy’s overall good news. Here’s why.Stan Choe | APon March 17, 2021 at 9:45 pm

All of the churning going on has a big impact because, more than ever, 401(k) accounts are tied to the performance of the S&P 500 and other stock indexes.

A huge shift is underway in the stock market that might roil your 401(k) in the short term but that many professional investors see leading to long-lasting gains.

A surge of optimism that the coronavirus pandemic is on the way out has investors looking to revamp where to put their money. As a result, most stock prices are rising, with the biggest gains coming from companies that would benefit most from a healthier economy, such as airlines and banks, which got pounded by the market for much of the pandemic.

At the same time, those hopes are prompting a rise in bond yields. And that’ sending a group of tech stocks back to earth after they carried the market for much of the pandemic. When bonds pay more in interest, investors are less willing to pay as high prices for stocks viewed as the most expensive or to wait as long for their big growth forecasts to come to fruition.

Because of how stock indexes are calculated, any weakness in the biggest stocks can mask strength sweeping across the rest of the market. It’s why the S&P 500 isn’t up much so far this year: Energy stocks have soared, and financial stocks also are up. But tech stocks, which account for more than one-quarter of the index’s market value, have risen just a bit.

All of that churning below the surface might sound like so much inside baseball. But it has a big impact because, more than ever, 401(k) accounts are tied to the performance of the S&P 500 and other stock indexes. More than half of the dollars in U.S. stock funds are directly mimicking indexes, according to Morningstar, the Chicago financial services firm.

So your 401(k) could fall even if the economy — and most stocks — are rising.

This is the mirror-image of what happened early in the pandemic, when the S&P 500 powered higher as the economy fell into a pit. And professional investors say this rotation among sectors still has room to run.

“It brings me back to business school, where we learned about how all the indices are different,” said Lamar Villere, a portfolio manager for Villere & Co. in New Orleans. “It seems so boring and academic. But there is not one monolithic thing called the stock market. It’s these hugely different areas of the market that are moving differently.”

Investors already have felt the moves in recent weeks, when expectations for coming inflation and economic growth suddenly hit an upswing as COVID-19 vaccines rolled out and Congress neared its $1.9 trillion economic rescue.

The Nasdaq composite tumbled more than 10% from Feb. 12 through March 5, with its many tech stock holdings hurt by the sudden rise in yields. The S&P 500 also fell during that span, by 2.4%, even as more than half of the stocks in the index were rising.

Marathon Oil and other energy producers led the way, with several up more than 20%. Cruise-ship operators also were steaming higher.

If the economy roars back soon, as nearly everyone on Wall Street expects, profits should jump much more for those types of companies than for big tech stocks, which benefited from the stay-at-home economy.

That’s why investors generally should take it in stride if the S&P 500 falls because of drops for a just a few heavyweight companies. Many analysts and professional investors expect the improving economy to boost profits for companies enough to more than make up for stumbles caused by rising rates in the near term. They expect the S&P 500 to rise over the next year.

Since tech stocks’ recent tumble, they’ve come back, as worries about inflation have been tamped down a bit. Even if tech stocks’ shine never fully returns, many continue to produce huge profits — such as Apple and its nearly $29 billion in net income last quarter.

But many professional investors still expect the rotation out of tech stocks into other beaten-down areas of the market to continue a while longer. Tech and high-growth stocks still look much more expensive than the rest of the market, and higher interest rates make that gap appear even more glaring. That could keep the pressure on the S&P 500 and index funds that track it.

High-growth stocks largely had been pulling away from their more cheaply valued value stocks for much of the past 15 years, said David Joy, chief market strategist for Ameriprise. Long term, a reversal could last just as long.

Within such long-term trends, the market can swing back and forth. For this most recent move into value stocks out of high-growth tech stocks, Joy said there’s likely months left to go.

“If I had to guess, it’s halfway to maybe two-thirds done,” he said. “But it’s still the place to be.”

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