May 22, 2023
Investment Strategy Brief: A Top-Heavy Market
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Below is a transcript of this week’s video.
U.S. large cap stocks have bucked bearish expectations year-to-date, with the S&P 500 posting a 9.1% total return so far. However, it has been a narrowly driven market, with the largest companies – Apple, Microsoft, Alphabet or Google, Amazon, Nvidia, Meta and Tesla – leading the fray.
In fact, those seven companies have accounted for the lion’s share of that year-to-date performance. Excluding the impact of these mega cap stocks, the S&P 500, based on the contribution to performance from the other 493 companies would be up a mere 0.9%.
To further this point, just two stocks out of the 500 – Apple and Microsoft – account for more than 1/3 of the market.
This contribution to performance in part comes from the size of these companies in the marketplace.
Focusing again on Apple and Microsoft, these two companies have together grown to become 14% of the S&P 500’s total market capitalization.
To some degree, this is justified, as their profits had grown similarly, up until the tail end of the pandemic. However, after this, they seem to have reverted back to more normal levels, while the prices of the stocks did not experience the same reversal.
Digging further, both the market capitalization and the profits of these companies appear elevated relative to other fundamental assessments, such as revenues or employee headcount. To some degree, this reflects efficiency, which is a good thing, but it also reflects a large profit source that competition is likely quite hungry to attack.
Another astonishing factoid that sheds light on the unusual magnitude of market cap concentration is that Apple’s market capitalization has just surpassed that of the entire Russell 2000, a broad small-cap index that includes 2000 companies.
Such a top-heavy market is unlikely to be sustainable over the long-term. It is important to note that the companies that rise to top often do not stay at the top forever. We should probably suspect that may happen this time as well.
So in summary:
- A small group of mega-cap stocks have single-handedly turned a roughly flat market for U.S. large caps into a near-10% total return year-to-date.
- More than a third of 2023’s total returns can be attributed to just two stocks: Apple and Microsoft.
- These companies have become unusually large relative to peers and their own fundamentals, making the market quite concentrated.
- Historically, there is a churn among the market’s top companies as they increasingly come under regulatory and competitive pressures.
- Investors should proactively diversify portfolios in light of the market’s increased concentration and excess valuations.
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