Concentration Concerns
Bradley Prosper, CFA®, CFP® XPYRIA Team Insights
Through June 30th, the S&P 500 Index is up +16.9% year-to-date (YTD), and we wanted to take a deeper look at what has driven the strong performance for the index. Seven of the largest stocks in the S&P 500 Index were responsible for 74% of the index’s YTD returns. Media sources like to apply catchy names to phenomena like this, and they’ve dubbed these companies the “Magnificent 7.”
The “Magnificent 7” are up +82.5% on average YTD, and they’re up +61.1% on a market cap-weighted basis. By comparison, the S&P 500 Equal-Weight Index is up +7.1%, while the S&P 500 ex-“Magnificent 7” is up only +5.7% YTD. That point bears repeating – seven stocks are up +82.5% so far this year, while the remaining 493 stocks are up +5.7%.
Source: Factset, data as of 6/30/2023.
While we do own these companies in client portfolios, we own them at a smaller weight than the S&P 500 Index does. We diversify client portfolios into international stocks and small cap U.S. stocks, which has been a headwind to relative performance given the S&P 500’s concentrated gains. These seven mega-cap Tech stocks now account for 27.7% of the S&P 500 Index. 5 and 10 years ago, the top seven stocks in the S&P 500 represented 13.7% and 16.8%, respectively.
Concentrated performance, especially when it comes from top names in the index, makes it difficult for active management to outperform. With the top names in the index now comprising such a large weighting, strategies that don’t own these handful of companies (or do own them but in a smaller weight than the index) struggle to keep up with the index performance. Active management tends to perform best when market gains are broad-based rather than driven by a small subset of constituents.
In a nod to the narrow market performance, I used a picture of “The Narrows” in Zion National Park as the image for our Q2 2023 Markets at a Glance. Below, you can see just how narrow the market has been in 2023 – only 27% of the companies in the S&P 500 Index are beating the overall index return (vs. the historical average of 49%).
Source: Ned Davis Research, data as of 6/14/2023.
The previous chart shows that this is the narrowest market since the late 1990s/early 2000s, which we remember well. We hesitate to compare the quality of today’s “Magnificent 7” to those that comprised the speculative mania of the late 1990s/early 2000s Dot Com Bubble. Many of today’s top contributors are high quality companies with real business models, cash flows, and moats around those businesses. Are some of these stocks overvalued? Perhaps. Is it possible that they become even more overvalued? Absolutely. In the short-run, news headlines and hype can drive a stock’s performance to either exuberant highs or pessimistic lows. But in the long-run, stock price is driven by the underlying company fundamentals. In the long-run, we believe a globally diversified portfolio that includes a mix of large cap U.S. companies, international companies, and small cap U.S. companies should outperform both the concentrated “Magnificent 7” and a domestic-only index like the S&P 500.
