Martin Pelletier
July 8, 2024
We’re witnessing something in today’s markets that has never happened before. Just 10 stocks make up 34 per cent of the S&P 500 index, beating the previous market concentration high of 33 per cent in 1963. These same 10 companies have now contributed to three quarters of the index’s return so far this year, with just one stock — Nvidia Corp. — accounting for nearly 38 per cent of the gains.
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An analysis by Crescat Portfolio Management LLC shows that when Nvidia’s enterprise value peaked on June 18 with a market capitalization of more than US3.3 trillion, it was worth the equivalent of 11.7 per cent of the gross domestic product in the United States, more than twice the level reached by Cisco Systems Inc. during the dot-com bubble of 2000. Add in the nine other top stocks and, combined, they are worth the equivalent of more than 60 per cent of U.S. GDP, also double the level the top 10 reached during the 2000 tech bubble.
Overall, the S&P’s 15 per cent gain through June ranks 21st since 1900, according to Goldman Sachs Group Inc. The good news is that in years when the index was up at least this much at the halfway point, it has been positive 72 per cent of the time for the rest of the year, for a further median gain of almost nine per cent.
Perhaps, then, this market has room to run. But the big question is whether the momentum in megacap stocks will trickle down into the broader market, something that was not the case in the second quarter, when the S&P 500 gained 4.3 per cent (in U.S. dollar terms) while the average stock in the index lost 2.6 per cent. The S&P/TSX composite index lost ground during that period, too, posting a 1.3 per cent price return decline.
For fund managers who benchmark their returns, this divergence in performance presents a problem. Those who don’t track the broader S&P 500 risk losing their investors and, as a result, many don’t have a choice but to succumb to FOMO (the fear of missing out) and chase the top-performing index.
As long as this continues, the gap between these 10 stocks and the rest of the market will continue to widen. Eventually, there will be a mean reversion and the longer the divergence goes on, the larger the correction will be.
Our approach via goals-based, risk-managed investing allows us to avoid this problem. Instead, we can hedge against some of the risks that could impact portfolios while continuing to focus on more absolute return strategies that are diversified across market segments. This means adding in downside protection while it’s inexpensive to do so without giving away too much of the broader global market upside.
However, you have to be comfortable with not fully capturing the returns from the tech rally — or whatever the market darling du jour happens to be — and focus instead on adding consistency within your return profile. This style of investing makes a lot of sense for those who want capital preservation paired with some growth.
A prime example would be entrepreneurs who have built a lot of wealth through their careers and are now looking to minimize the risk to their capital while still growing it at a reasonable rate.
Having a more stable return profile helps minimize excessive risk-taking due to FOMO during big rallies and can also prevent permanent erosion of capital due to loss aversion whenever the next correction comes around.
These types of investors and their advisers should be willing to go against the crowd and do their own thing. For us, this includes deploying different strategies such as structured notes, buffered option strategies, currency hedging and some private equity.
Active rebalancing and tactical asset allocation should also be considered. For example, we’re currently focusing on those areas of the equity market that will benefit from falling interest rates.
That said, this approach may not be as desirable for younger investors as owning the growth-oriented segments of the market, which has proven to be very rewarding. Any larger corrections in high-flying tech names would actually be beneficial, given that younger investors are only in the early stages of saving for retirement and, therefore, are able to take advantage of any repricing.
However, it’s helpful to remember there isn’t always safety in the herd. Make sure you’re investing based on your own goals and objectives and not trying to keep up with or beat everyone else.
