The S&P 500 has never been more top heavy

As published in the Minneapolis Star Tribune 08/15/2020.

Never before has the S&P 500 been as top-heavy as it is now.

The five largest companies by market capitalization (Apple, Microsoft, Amazon, Facebook and Alphabet) comprise more than 22% of the index. Those five companies have as much influence on benchmark performance as the bottom 363 companies combined. When it comes to the most widely cited index for U.S. equities, not all stocks are weighted equal.

Earlier this month, Apple grew big enough to represent 6.5% of the S&P 500, breaking IBM’s previous record set in 1985. Is Apple really 27 times more valuable than Goldman Sachs? Is Microsoft 12 times more valuable than Medtronic? Is Facebook 13 times more valuable than FedEx?

If we are measuring by market-cap, the answer is yes. Yet, when it’s time to make your next 401(k) contribution, are you comfortable investing so much more money in those companies just because they are big?

The S&P 500 being dominated by a few companies isn’t new, but the concentration is more extreme. Over the last 25 years, the five largest stocks represented about 13% of the index, on average. In 1999, during the dot-com bubble, the number rose as high as 16%. It didn’t get that high again until 2018.

Some of this can be explained by innovation. The current formidable five created (or popularized) the smartphone, the personal computer, social media and online shopping. No American under age 30 can imagine life without them.

Aggressive acquisitions is another key. Alphabet (formerly Google) is a new-age conglomerate. Once defined by its internet search engine, the company now owns a little bit of everything: Android, YouTube and Motorola among them.

The rise of passive investing has contributed as well. Not all index funds, of course, are market-cap weighted, but the most popular ones certainly are. An investment approach predicated on “bigger is better” creates huge demand for the largest stocks based on size alone.

On top of all that, the seismic shift to a pandemic-induced work-from-home culture disproportionately benefited Big Tech stocks. Investors viewed their revenue streams as less affected by an economic shutdown.

While buying big has been a successful strategy this year, there are obvious risks. Investors buying new shares in the five biggest stocks will be chasing recent performance. Historically speaking, most companies that get near the top of the index are more likely to retreat than to grow those weightings further. There is also the threat, or inevitability, that some get dismantled through antitrust proceedings if the government deems it necessary.

Further, if you are betting on an economic recovery, many of these names could actually fare worse, relatively speaking. Much of their year-to-date gains are due to the extraordinary circumstances created by coronavirus. If conditions improve enough to warrant a more broad-based rebound in cyclical stocks, the S&P’s heaviest hitters could well end up lagging.

If nothing else, it’s healthy to understand what is driving index performance. The S&P 500 has outperformed its equal-weight equivalent by more than 700 basis points this year. It’s one more reminder there isn’t as much balance in the benchmark as there used to be.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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