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There is no denying the impressive performance of the S&P 500 over the past decade. Some of the numbers are remarkable. This dominance has led some investors to wonder if they should abandon other equity markets and allocate everything to the S&P 500. While I understand the temptation, history shows that this strategy rarely pans out. We all fall prey to being prisoners of the moment; it's a natural reaction.
Most market headlines these past few years have been about the S&P 500’s continued outperformance. The reality is that much of the dominance has come from a handful of stocks. In 2013, a few stocks, coined FANG, helped propel the S&P 500 for a few years. In 2017, FANG morphed into the acronym FAANG and, today, the MAG7.
These seven stocks, mainly U.S. tech companies, comprise a roughly one-third weighting of the entire index, with the other 493 stocks representing the remaining two-thirds. During the first six months of the year, Nvidia, Microsoft, and Google alone accounted for ~50% of the index’s total return! Even more eye-opening is that as of this writing, these seven stocks account for ~70% of the S&P 500’s year-to-date gains.
While it's unlikely these same stocks will continue at this rate, there’s no reason another handful within the S&P can’t carry the torch for the remainder of this decade. They would grow to become a larger percentage of the index while the MAG7 names would retract some.
Dating back to 1980, the top 10 stocks in the S&P 500 generally make up ~20% to 25% of the index. Today, we are at ~35%, and nearly all of it comes from the MAG7. So the reality is the S&P’s outperformance is more a function of a few stocks and less about the entire index.
In my opinion, the most pressing concern is how three stocks (Microsoft, Apple, and Nvidia) account for ~21% of the index. You have to go back to 1973 to find a similar situation, where the top three stocks made up ~17% of the index.
This situation means you should expect a little more volatility than usual moving forward. Unless a small handful of stocks replicate similar performance over the coming years, we‘re likely to see some reversion where other equity markets outperform. I know it seems hard to even imagine that right now, but patience is a virtue.
With that being said, as seen on the chart below, the S&P 500 has clearly outperformed other indexes over the past 20 years, and in some cases, by a WIDE margin.
The disparity in the numbers above makes it hard not to draw concrete conclusions. The truth is, the devil is in the details. Most of this outperformance has come in four of the past six years. This is not to say it can’t continue, but it hasn’t been a consistent 20 years of outperformance. It really boils down to three years (2018, 2021, and 2023).
As seen on the chart below, the S&P 500 actually lagged most broad equity markets over a 14-year stretch from the start of 2004 to the beginning of 2018!
While the S&P yielded a great return over this period, it significantly lagged the mid-caps (MDY) and was solidly behind both small-cap (IWM) and emerging markets (EEM). This gap generally widens when using small and emerging market funds that focus on value and profitability metrics, as we do.
The reality is unless you can time markets with a high degree of certainty, things are not always as simple as they appear. Back in 2018, some were likely questioning the logic of owning a large percentage in the S&P 500, and look at what’s happened since: It flourished. If they weren’t questioning it then, they definitely were for the four years from the start of 2004 to 2008, as seen on the chart below.
Of course, times change, and different forces are at play. Yet the likelihood of a single market consistently outperforming year in and year out is low. Can U.S. tech companies continue to dominate for the remainder of this decade? While possible, it seems unlikely, as the MAG7 would need to make up ~45%-plus of the S&P 500 index. Other stocks could pick up the slack, but it’s unlikely to the same degree these seven have over the past five years.
Now, this doesn’t mean you shouldn’t overweight certain markets over various periods, but completely abandoning them is a risky proposition. And trying to figure out when to get back in is even more difficult.
A good example that comes to mind is emerging markets. As a whole, this index lost -18.7% during a three-year stretch spanning from the start of 2013 to the end of 2015. The reasons for owning it were fading, and so were the inflows. Well, a funny thing happened. It returned slightly over 50% the next two years!
Did fundamentals change that much? No. Did emerging-market economies take over the world? No. Much of it was a reversion to the mean as this market became significantly undervalued and had a two-year run no one saw coming.
So what’s the bottom line here? A diversified investor should always expect one of their holdings to lag the others, and quite often for multiple years. This is not uncommon and should be expected. Now, the length and level of outperformance will vary, but the concept remains. Staying invested and diversified is the best long-term strategy yet will produce the occasional short-term headache.
Stay the course …
Discuss your situation with a fee-only financial advisor.
Ara