Actually, Size Is Everything
The U.S. stock market has now retraced more than 50% of its losses during the corona-crash. While this is surprising and positive, the composition of the rally is cause for concern. It is ever more dependent on a few large stocks, particularly the mega-corporations that dominate the internet.
For one illustration, this chart shows how large-cap companies have performed compared to small-caps in the U.S., the rest of the developed world, and the emerging world, according to the MSCI indexes. In all cases, large-caps have greatly outperformed during the crisis. Mega-caps, represented by Russell’s Top 50 index for the U.S., have outperformed particularly. In general, the leadership of the big is a U.S. phenomenon:
It should surprise nobody that this is primarily about the FAANG internet stocks. Initially named for Facebook Inc., Amazon.com Inc., Netflix Inc. and Google, the moniker has widened since then. The NYSE Fang+ index also includes Apple Inc., Nvidia Corp., and some of the big Chinese internet names, such as Alibaba Group Holding Ltd. Usually when an index is set up to exploit a popular investing acronym, that suggests it’s about to run out of steam. Certainly not this time. This is how the Fang+ index has done compared to FTSE’s all-world index since inception in 2014:
The lockdown has given this trend extra juice. In particular, Netflix and Amazon are seen as companies that will unequivocally benefit as a result of our current incarceration. The following chart, which starts with Netflix’s poorly received results for last year’s second quarter, shows that both companies had been out of favor until the lockdown — and then suddenly turned around:
As I said yesterday, I believe there are reasons to doubt that these two companies really will win in the long term. The bet on them looks over-extended.
In the long run, what is perhaps more concerning is the extent to which the entire U.S. market has grown top-heavy. For these purposes, the acronym to worry about is “FAMAG” — Facebook, Amazon, Microsoft Corp., Apple and Google (which these days trades under the name of parent company Alphabet Inc.). These are the five largest companies in the S&P 500 by market cap, and have been for three years (Exxon Mobil Corp. kept Facebook out of the top five in 2017). The following chart shows the combined weight of the five FAMAG stocks in the S&P 500 on this date for each of the last five years:
(I drew it myself on Excel using Bloomberg data — apologies for problems with the graphic software). Their weight has doubled in five years, starting from a level when they were already ensconced as the greatest financial phenomena of the age.
Generally, buying the largest stock in the S&P 500 over history has been a bad idea. Such stocks have nowhere to go but down. Just in the last 30 years, General Electric Co. and International Business Machines Corp. both spent a lot of time at number one, as more briefly did Coca-Cola Co. and Cisco Systems Inc. In the case of FAMAG, buying the leading juggernauts, holding them, and waiting for them to extend their lead over everyone else has been the right strategy for at least half a decade.
When you buy a stock you are buying a share of its future profits, not its past. Are these companies really going to stay this dominant into the future? A market this narrow suggests that some bad news, or reason to shake confidence in one or more of the FAMAG stocks, could shock the whole market. While confidence in them remains this strong, though, the main index is unlikely to go back to its lows of March.
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