A Case of Bad Breadth
October 30, 2023 | By Matt Pierce
Through much of the year, strong year-to-date gains have been touted, and even despite a near 10% selloff since July, the S&P 500 remains up over 8.5% year to date. However, that strength has come from an ever narrowing list of companies. Their performance has been so fantastic they’ve been dubbed the “Magnificent Seven” in large part fueled by AI’s mainstream explosion this year.
They also represent the seven largest constituents within the S&P 500. After a pause during last year’s rout in technology and growth stocks broadly, their outperformance has created a significant concentration of the market in these big winners. Those seven names make up an astounding 28% of the S&P 500.
The situation below the giant company surface has been less than stellar, and their strength continues to mask a significant deterioration in the majority of other stocks. This pronounced impact is illustrated in the charts below.
The Nasdaq – 100 is still up over 30% YTD in no small part due to the staggering 43% weight to the “Magnificent Seven.” At the opposite end of the spectrum, the equally weighted S&P 500 index significantly reduces the performance impact of the largest components and is now negative on the year down nearly 4%!
Shown another way, every single sector within the S&P 500 is down on the year with the exception of the respective homes of the “Magnificent Seven,” Technology (Apple, Microsoft, Nvidia), Communication Services (Meta, and Alphabet), and Consumer Discretionary (Amazon, & Tesla).
Even within those top sectors, the performance is drastically reduced by equal weighting. The Equally Weight Consumer Discretionary Index has even turned negative on the year when removing the impact of the large members like Tesla and Amazon!
What does all this mean for investors?
Due to the dramatic spread between the “Magnificent Seven” and the rest of the market, just owning less of these stocks has been a serious impediment to keeping pace with the major stock market indices like the S&P 500.
While the majority of strategies we pursue do own all of these stocks, they seek to do so with an eye to the price they pay for them which typically translates into owning less of stocks that may have gotten ahead of their underlying company fundamentals.
These periods of underperformance are as frustrating as they are inevitable. Any strategy will have periods of underperformance. One need only look back as far as 2022 which saw a significant unwind in market concentration and the attendant underperformance of those same indices relative to strategies more conscious of price.
A broader view of history has rewarded investors that remain attuned to the price they pay for their underlying investments; however, that same history is replete with short windows, like 2023, which have tried even the most disciplined of investors. We are social creatures, and the feeling, conscious or not, of “losing” relative to our perception of our peers can be even more painful than actual losses in an absolute sense.
While unfortunate that the pain part seems a requisite, we remain convinced that investor discipline will again be rewarded.
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