The dominance of a handful of the largest companies in the market, as measured by the S&P 500, is dramatic.
Scott Minerd, Guggenheim Partners CIO, said last week, “I have never in my career seen anything as crazy as what’s going on right now. We are in ludicrous season.” Some might say these comments are a little over the top, but just look at one of the extreme situations that Scott is referencing.
The chart above shows the Market Cap of the top 5 companies in the S&P 500, along with their corresponding weights in the index. What you will notice is that, as of last month, the top five names represent more than 17% of the entire index. For some additional perspective, one of HCM’s institutional consultants, Ned Davis Research put out a note this week stating that 29% of the All Country World Index (ACWI) is represented by its top 40 stocks. This narrowing of leadership is reminiscent of the Tech Bubble, though we still have a way to go before reaching the peak of a 39% concentration of early 2000.
Why Do We Care?
If we aren’t at “Tech Bubble” extremes, is it really any cause for concern? Yes and No. Narrow markets are like a house of cards. They take a long time to create and can be extremely fragile if the wrong card is removed. The popularity of indexing has mandated that every dollar invested in a cap-weighted strategy, such as the S&P 500 allocates 17 cents to those top 5 names. It creates a buying cycle that feeds on itself. At the same time, if these companies continue to perform well, the index will continue to move higher, even as valuations become more extreme. This continued narrowing of the market remains a key reason why we maintain a portion of our U.S. large-cap equity exposure in an equal weight allocation to complement our capitalization weighted holdings.
Considering that valuations are already at very elevated levels, the economy has now gone a decade without a recession and there is a virus that has slowed down the Chinese economy, it is somewhat fair to ask if investors are ignoring the risks associated with a move to “ludicrous season.” From an economic standpoint, it seems almost impossible to envision a current scenario where the global supply chain isn’t disrupted in some way from the spread of the virus and resulting quarantines. Yet, the market continues to press higher as if nothing is wrong. Massive liquidity injections from both the Chinese Central Bank and our own Federal Reserve have stemmed the tide for now. Investors seem to be counting on more stimulus being added if the situation gets worse.
To Mr. Minerd’s credit, many investors are expecting a correction at any moment. Most of these market doubters would likely also agree that trying to predict the market is a loser’s folly. It is important to remember that the market is the ultimate arbiter of price and right now the market is telling investors to “keep the faith,” that central banks will have enough firepower to take each and every bad scenario off the table as they come, even those as big as disrupting the supply chain running through China.
The reality of the moment will be true until it is not. Those of us old enough to have lived through several bad markets know the current reality can change in a heartbeat. This is important knowledge for those managing portfolios whose job is to provide sustainable-growing income through retirements that will last over many decades to come.
We continue to focus on maintaining a balance that is dictated by price and governed by reasonable forecasting. Price trends remain very strong and must be respected for their potential to continue to move higher. On the opposite side of the coin, it seems irresponsible to believe that the economic disruption resulting from the coronavirus will be ignored by investors forever. It is already starting to have an impact as Apple announced that they would miss their revenue target this quarter due to supply chain issues directly related to the virus. When one of the most recognizable companies in the world is providing warnings, you can be sure others will follow.
If we begin to see price weakness match the potential economic warnings, we will begin to shift portfolios toward a more defensive positioning. But for now, the sermon of the central banks continues to be accepted as gospel.
Weekly Focus – Think About It
“A photograph is usually looked at - seldom looked into.”
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Gain of 1.94%
- Developed Foreign Markets (EFA) – Gain of 0.35%
- Emerging Markets (EEM) – Gain of 1.79%
- Fixed Income (AGG) – Gain of .06%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- The spread of the coronavirus continues to dominate headlines, with both confirmed cases and deaths continuing to move higher.
- Total retail sales increased 0.3% month/month in January, which was in line with expectations and will contribute to expectations that Q1 GDP will see a modest increase.
- University of Michigan’s Consumer Sentiment Index increased in February to 100.9, up from 99.8 in January as consumers remain confident in both job security and income growth prospects.
Eye on the Week Ahead
- Readings on PPI will provide a small glimpse of any inflationary pressures building. The consensus is that the report won’t provide the Fed any ammo to raise policy rates soon.
If you have questions about the recent market conditions, please contact a member of HCM’s Wealth Advisory Team:
Any tax or other advice contained in this document, including any attachments, is not intended and cannot be used for the purpose of avoiding penalties under Internal Revenue Code. No action should be taken on any information contained in this message without first consulting with your tax/legal advisors regarding the tax/legal consequences for your particular circumstances.
- The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
- Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
- Past performance does not guarantee future results.
- You cannot invest directly in an index.
- Consult your financial professional before making any investment decisions.
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