Your Favorite Indexes Might Be Missing The Next Big Winners

Your Favorite Indexes Might Be Missing The Next Big Winners
Stéphane Renevier, CFA

over 1 year ago1 min

Mentioned in story

Market capitalization-weighted stock market indexes are fickle things. See, when a specific sector is doing well, the market capitalization of the biggest companies within it will plump up. So the better a sector is performing, the heavier its weight in the index – and that could be a problem.

Today’s weighting looks a lot like it did during the tech bubble of 2000. There’s a heavy lean toward the technology, consumer discretionary, and communication sectors (green line) that have been buoyed up by years of low interest rates and inflation, overshadowing the financials, materials, and energy sectors (gray line).

But the chart above suggests the tide may be about to change: just like in 2000, rising interest rates – hiked up to tackle stubborn inflation – are tugging down those more discretionary stocks. High rates have doused a cold shower on speculative sectors like tech, while inflation’s darkened the outlook for consumer spending. At the same time, sectors that are less impacted by rising interest rates and more insulated from high inflation – like the previously unfavored financials, materials, and energy sectors – are starting to tick upward.

This might just be the start: the chart also shows that the financials, materials, and energy sectors outperformed the former winners by a significant margin in the decades following the tech bubble’s bursting. So if inflation, interest rates, or volatility stay higher for longer, or if investors become more risk-averse, we might see something similar over the coming decade. In that case, holding a market cap-weighted index like the S&P 500 – which is now full of past winners, rather than future ones – might not be your best bet. Instead, it could be prime time to bet on new winners – thankfully, I’ve covered a few alternatives here.

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