Via @PortfolioMeta on X - a historically low number of individual stocks within the S&P 500 (the US stock market) have outperformed the index year to date.
Source: @PortfolioMeta, X.com.
The first takeaway from the above (to my small mind at least) is that in most years, the majority of stocks underperform their index.
Therefore if you are in the business of trying to beat an index by investing in individual names, the numbers tell us that you won’t necessarily have the wind at your back.
It is also easy to forget sometimes, I certainly do, that the stock market isn’t just this abstract number. It is, quite literally, a “market of stocks”. And over the past couple of years, the overall return of this market has been carried by just a handful of companies.
As a consequence of this narrow performance, the proportion of the total US market that is held within the largest companies has been only going in one direction. Stock market “concentration” has been on the rise.
The blue line depicts the percentage of market capitalisation represented by the top 5 stocks among the 3,000 largest publicly listed companies in the US at each point in time. Source: Haver Analytics and Fidelity Investments, as of April 30, 2024.
This isn’t just a US phenomenon either.
Source: LSEG Datastream, MSCI and Schroders Strategic Research Unit. Data as at 30 September 2024.
At first blush, this all sounds like a bad thing. If all of the performance in a given market is coming from only a handful of names - surely that is inherently dangerous?
That is certainly what is implied by the first chart I shared above. The last time that the performance of the US market was driven by so few individual stocks was just before the “Dot Com Crash”.
An overly concentrated stock market being an unhealthy one is certainly a neat story, and one that makes intuitive sense. It’s certainly a narrative that is happily pushed by the usual Doomsday merchants.
Just a shame then that it is total nonsense. The US market has actually done better in the past when concentration has been on the rise.
Source: Morgan Stanley.
Things need not go badly from here either. Instead of the largest stocks in the index beginning to fall and bringing down the market with them, the rest of the market can catch up and outperform.
This is exactly what we have (mostly) seen in the past. The below (excellent) chart from Schroders shows that following periods of high market concentration, a simple “equal weighted” strategy will usually outperform the “market cap weighted” index equivalent.
Source: LSEG Datastream, S&P, and Schroders. Data to 31 December 1989 to 31 January 2024.
Whisper it quietly, but there are signs that history could be repeating. The below (less excellent) chart shows the performance of an S&P 500 Equal Weighted Index versus the regular S&P over the last three months.
Source: FE Analytics. Returns are shown in Sterling terms.
A couple of swallows don’t make a summer, and there have been plenty of false starts for smaller companies over the past few years, but there is definitely a world where market concentration reverts towards the mean without everything falling out of bed. Where performance comes from “everything else” rather than the biggest names.
I know it’s been quite technical this week, but my broad point is this.
There are lots of people out there that spin narratives to suit themselves. Everyone’s selling something.
Quite a lot of the time, these narratives can make a lot of intuitive sense too.
But the devil is almost always in the detail. Either ignore the spin, or do the digging.
Have a great weekend.
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