2021 Has Been a Good Year for Stocks, at least a Handful

The S&P 500 is two weeks away from finishing off an impressive year. After logging an 18+% return in 2020--recovering from a disastrous start to rally 65% from the March 2020 lows--the blue-chip index is set to add another 20+% return again in 2021. You can’t argue that the most watched and tracked index in the world is generating wonderful returns for investors. However, while the index comprises 500 of the largest companies in the United States, it cannot really be said that the spoils of the grand returns are spread equally.

It seems that the ills of our society are also the ills of the stock market. The rich get richer and the poor…well, not so much. Goldman Sachs reported this week that the top 1% of the S&P 500 companies, yes 5 stocks out of 500, have contributed over 50% of the total S&P 500 gains since April. How does this calculation work, you may ask? The S&P 500 index is a market-cap weighted index which means that each stock’s percentage of the index is proportionate to its size. Microsoft, for example, came into 2021 with a weighting of about 5.3%. For the year, MSFT stock is up about 50%. 50% multiplied by 5.3 %, implies a contribution to the S&P 500 return of 2.65%, or roughly 10% of the S&P 500’s total return.

Currently, the largest 5 companies in the S&P 500 make up 22% of the overall weight of the index. These stocks are Apple, Microsoft, Nvidia, Tesla, and Google. If you add Facebook and Amazon to the list the weighting of these tech behemoths rises to 28.3%. That’s a lot of concentration risk for a supposedly diversified index. Maybe it feels like owning those companies is a no-brainer; after all, their position at the top may seem secure. Who can really challenge these players in their field of expertise? All that may be true, but the nature of capitalism is that profit margins are mean reverting. Once a niche is exposed as being highly profitable other players invade which can drive margins lower. Conversely, when margins are razor thin, players drop out causing margins to increase. Unless capitalism is dead, which quite frankly is not beyond debate, past returns of these companies are not necessarily indications of future returns.

While this time may be different, which it rarely is, piling into these stocks can be fraught with peril. The last time 5 stocks commanded such a large presence was in 2000. At that time, Microsoft, Cisco, Exxon Mobil, General Electric, and Intel represented 18% of the S&P 500. In 2000, had you simply bought those top 5 stocks expecting their dominance to continue you would’ve been quite disappointed. For the decade prior, holding those 5 stocks would have returned over 51.5% annually. An investment of $10,000 in 1991 would’ve yielded you a portfolio valued at $426,000 by January 2000. However, holding those same 5 stocks over the last 21 years would have only returned 5.6% annually. In fact, after your first 10 years of holding those stocks, you would’ve been down 30%. Accounting for inflation it would’ve taken you until 2015 to just breakeven. Not exactly the returns worth writing home about.

Comparing that to the leaders today, a portfolio consisting of Microsoft, Apple, Nvidia, Tesla, and Google would’ve returned 52% since January 2012. That return is nearly identical to the return of the previous stalwarts of 2000. The only thing that remains to be seen is if history repeats itself, or if this time it really can be different. We write quite a bit about the advantages of momentum as a powerful factor in investing. Momentum has a much stronger influence over shorter term behavior than it does over longer-term behavior. As a regular cigar smoker, the chances of me smoking a cigar tomorrow is quite high, the chances that I’ll be smoking in 20 years are not as high—in fact, I may be gone. The same can be said for the prospects for these 5 dominant stocks, only time will tell.

Thanks for reading,

Zach and Dave

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