Joy and exuberance returned to the equity markets in October, with September’s losses more than made up for and the major indexes hitting new all time highs. The S&P 500 gained 7.01% on a total return basis, bringing it to up 24.04% over the first ten months of the year.
As we make the home turn into the end of 2021, this seems like a good time to reflect on what has been a remarkable few years in the market. Since the end of 2018, the S&P has almost doubled, up 97.57%. Perhaps even more impressively, and almost implausibly, it is up 46.87% since 2019, a 22-month period dominated by a global pandemic. How the pandemic drove those returns was surprising to many of us. Instead of being inspired by caution and led by such sectors as consumer staples and healthcare, the market has instead been dominated by a short list of very large capitalization growth stocks.
That the S&P has been increasingly concentrated into just a few names is hardly an original observation. We have discussed it here several times. But a longer-term perspective may be helpful. Below is the percentage of the S&P 500 accounted for by the five largest companies in the index, since January 2000.
In the comparatively recent past, just six or seven years ago, the five largest accounted for about an eighth of the index. Today it is much closer to a fourth. (23.41% as of the end of October.)
And the index is now concentrated in a way that the numbers do not show. Twenty years ago, on October 31, 2001, the five largest companies in the index accounted for about 15% if it. They were Exxon, General Electric, Microsoft, Pfizer, and Wal-Mart. Each was a dominant giant in its field, but that was nearly all they had in common. A portfolio of the five would have been modestly diversified.
Today, the top five are Alphabet/Google, Amazon, Apple, Microsoft, and Tesla, which nudged out Meta/Facebook a few weeks ago. A very earnest person might argue that this list is diversified, made up of an advertising company, a retailer, a maker of cell phones, a software company, and an auto manufacturer. But we all know better. All five share a common theme. They are high-profile technology-oriented companies with familiar consumer products and celebrity founders. A portfolio of the five would be far from diversified.
And, of course, a portfolio of the five would have performed spectacularly well recently. It is hard to exaggerate the degree to which these few stocks have been driving the broader market. The chart below shows the S&P 500 on a total return basis for the past ten years, divided into the Top 5 largest companies and the remainder, the “S&P 495.” (The Top 5 and S&P 495 is rebalanced monthly.)
For the 22-month period just ended, in which the S&P 500 gained 46.87%, the S&P 495 gained 35.85%. That is still an impressive return that would thrill most investors, but without just five names the S&P would have done 11.02% worse. And that accounts only for the direct effect of the Top 5. Presumably, the increasing prices of these leaders have dragged up the prices of more mortal stocks by comparison.
Over the same 22-month period the Top 5 was up 97.57%. The five now have a combined market capitalization of $9.6 Trillion and collectively made $261 Billion in profit over twelve months ended September 30, 2021, for a price earnings multiple of 36.8.
Predicting the future is always very difficult, particularly when current circumstances are so unique. But something modestly similar happened at the very start of this century, at the height of what was afterwards named the Dot-Com Bubble.
On March 31, 2000, the Top 5 made up 17.83% of the S&P 500. It included Cisco, General Electric, Intel, Microsoft, and Qualcomm. That is four tech companies and a conglomerate with a then celebrity CEO and an unlikely cult following among investors.
Microsoft is still in the Top 5. And the other four? Did something terrible happen to them? Not really. GE has had some challenges recently, but overall, all four are alive and well, large, successful, and profitable. What happened was that investors gradually fell out of love with them, and their valuations came back down to Earth.
Over the 18 months that began March 31, 2000, the S&P 500 declined -29.26%, while the Top 5 lost -40.38%. By September 2001, the Top 5 no longer included Cisco, Intel, and Qualcomm. They were replaced by Citigroup, Exxon, and Pfizer.
