over 3 years ago • 2 mins
For the first time in fifty years, the top five firms on the US stock market are worth as much as the bottom 350 – but the subsequent experience of those Seventies giants suggests today’s investors might benefit from a bit more ballast... 🎈
Investors buying an exchange-traded fund (ETF) tracking the value of the S&P 500 might assume they’re getting exposure to 500 companies. But as with many indexes, that exposure is typically “market value-weighted”; the more valuable a company’s stock, the bigger the slice of the 500-strong pie it represents.
As flagged a few weeks ago, a rush to the perceived “safety” of Big Tech means just five stocks – Apple, Microsoft, Amazon, Facebook, and Alphabet – today account for 23% of the entire S&P 500's value. That’s more than the bottom 350 firms in the index; although this phenomenon is even more marked in the tech-heavy Nasdaq 100, where the first three firms alone are worth as much as the bottom 87… 🤯
The last time such levels of unintentional “concentration risk” existed in the US stock market was 1975, when IBM, Proctor & Gamble, Exxon Mobil, 3M and General Electric were flying high. And that old-school roll call is a reminder that the biggest companies rarely, if ever, remain so…
Big Tech managed to avoid any nasty earnings surprises last month, but the risk of its outsized influence dragging down the entire value-weighted stock market remains. True, you might be content to sit back and let the top five stocks do all the heavy lifting while things are headed up – including dividends, the S&P 500 has delivered investors a 71% total return over the past five years, helped by the fab five’s combined 277% return.
But as fund manager Invesco pointed out this week, echoing recent concern from bank Goldman Sachs, investors are currently vulnerable to Big Tech’s inflated valuations (more than double the S&P 500 average) getting punctured – perhaps due to emerging competition, regulatory intervention or a general “rotation” to cyclical stocks.
One way of reducing this risk while maintaining exposure to America’s top 500 companies is to instead invest your primary stock allocation in an “equal-weight” ETF – one which puts 0.2% of your cash in every firm, regardless of size. It’s an approach which can still deliver decent returns – just with a bit more diversification…
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