When 5 stocks make you ignore 495 others, that’s an issue
We are far enough into the year 2020 where some clear patterns can be seen. No, I am not talking about the huge drop in the market during the first quarter. Everyone knows about that.
You are probably aware of the strong bounce in the S&P 500 since late March. You might even be having more of that FOMO (Fear of Missing Out) that got so many investors in trouble when 2019’s euphoria and feeling of invincibility turned to mush.
However, when we look inside the data from this most recent rally, we see a distinct pattern. And, when we go back further, we see that this same pattern has been in place for years, not weeks. What it tells us is that while the bull market lasted a long time (over 10 years) and recently became a bear market, the later years of that bull market were less than meets the eye.
In the process, it faked out many investors. Sadly, it continues to fake them out. Because there are 2 types of rallies: the kind that make nearly everyone a winner, and those that fool people into thinking their portfolios are “well-diversified” when they are not. What we have had the past several years is the latter. And, it is bound to steal more retirement dreams if the investing public is not more careful.
Here is the breakdown. I give it the code name “S&P 5.” That’s because 5 companies in the S&P 500 are accounting for a very outsized portion of its gains. This is in part because those companies have operated successfully, which raised their stock prices. But it also has tilted the S&P 500 Index toward them, with nearly 20% of that index now in these 5 companies. In a strong market, that masks broad market weakness. But as the Dot-Com Bubble Era and others have shown, it can be a double-edged sword to the uninformed.
I can tell you from personal experience over the last several years that when you look at your portfolio stock by stock, and see more of a mix of winners and losers than the “headline” indexes imply, you start to look deeper. When you do, you see many stocks whose performance cancels each other out. But the S&P 5 make everything better. At least, they have for a while.
The first chart shows you this in living color. The S&P 5 (Apple AAPL, Amazon AMZN, Alphabet/Google, Facebook and Microsoft MSFT) are all flat or up this year. The S&P 500 Index is down 10% through mid-day Thursday.
However, the bottom line (worst performer) on this year-to-date chart above is down 17%. What is it? It is the S&P 500. But wait, didn’t I just say that the S&P 500 is only down 10%? The pink line is the same 500 stocks, but weighted equally in the index. In other words, the average S&P 500 stock is down 17% this year.
But when you weight them according to how large the outstanding amount of stock is, those 5 big companies lift the index. Reality or fake news, depending on how you look at it. Either way, the facts are real. And it shows how much of an optical illusion indexed investing can be if you don’t really know what you own.
Below, is the same group of 5 stocks and 2 versions of the S&P 500. However, instead of year-to-date, I go all the way back to the start of 2016. In retrospect, this is when I think the latter stages of the last bull market began. In fact, in my firm’s client reports, in addition to showing some standard performance periods, we recently added performance since 1/1/2016 as an additional data point.
As you see, the S&P 5 all appreciated by 70%-258%. The capitalization-weighted “headline” S&P 50o gained 42%. But the average stock within the S&P 500 is only up 25%. In more than 4 years! Long-term, that’s a decent return of about 5% per year. But do returns like that make you adjust your perspective on how the last several years have gone? It should.
That’s around the time the Federal Reserve saved what probably should have been a mild recession, and pumped up the economy so that we could have a much bigger recession now. I believe this is where the big-time FOMO started, and it continues today. Which is why narrow bear market rallies like this one, while they happen and go on longer than most think they will, are still bear market rallies.
Pay attention, know what you own and why you are performing the way you are. And don’t get complacent. Otherwise, you are just faking yourself out.