How “the market” is becoming more like a tech fund … the impact of the FAANGMs on the leading indices … tech is having outsized influence on all sorts of funds … invest in tech or be left behind
My stocks suck.
Earlier this week, I caught up with a friend with whom I haven’t spoken in some months.
When the conversation turned toward the markets, his mood soured.
Apparently, when stocks plunged in February and March, his portfolio took it on the chin as did just about everyone else’s.
But in the subsequent recovery, he’s noticed that his portfolio is significantly lagging the S&P (which resulted in the eloquent description of his stocks that opened this Digest).
We began speaking in more detail about what stocks he owns. He mentioned a fair number of household names and reputable brands, as well as some other stocks and funds I wasn’t as familiar with.
But one thing I noticed was a general absence of “tech.”
When I pointed this out and suggested that’s why he’s trailing the S&P, he seemed a little confused. My friend wasn’t aware of a simple reality …
The S&P has begun to behave a bit like — well — a tech fund.
In our markets today, tech is driving the majority of gains. It’s that simple. Now, tech can be pure-play, such as investing directly in Amazon. But many indices themselves — like the S&P — are reflecting more “tech.” And this is influencing the returns of those indices, creating the appearance of big gains from “the broad market,” when the reality is less so.
Today, let’s pull back the curtain on just how big of an issue this is.
If you’re like my friend who has been wondering why he’s trailing the S&P, perhaps you’ll find the answer.
***The S&P 500 has almost become a tech fund
Most of us have seen the headlines that big tech is now dominating the S&P. But to what extent, exactly?
Let’s begin by making sure we’re all on the same page.
The S&P 500 index includes 505 of the largest companies in the United States. However, it’s a “market cap weighted” index, so these 505 stocks aren’t equally represented.
A market-cap weighting means that the bigger the stock (by market cap), the more weight, or representation, it has within the index itself.
This is different than an equal-weighted index, where each stock would receive the same weighting. For the S&P 500, we’d simply divide 100% by the number of companies (505) to get a 0.198% representation per stock.
But given the S&P 500’s market-cap weighting, it’s almost become a crude tech fund because the biggest stocks in the S&P are all tech stocks.
We can see this by evaluating the impact of the FAANGM stocks on the index. “FAANGM” is the acronym used to reference Facebook, Amazon, Apple, Netflix, Google (Alphabet), and Microsoft.
The FAANGMs also happen to take spots 1 – 5 on the S&P’s “largest companies” list. So, how much “share” does the FAANGM complex now have of the S&P 500?
Remember, for context, if the index was equal-weighted, the answer would be a combined total of 1.19% (0.198% x 6).
It turns out, the answer is 26% as you can see below.
Source: Yardeni Research
Now, how does this excessive concentration in the FAANGMs affect the returns of the S&P 500?
Well, let’s break it down a bit …
Below, we see the S&P’s returns, starting on December 28, 2012. So, this includes the FAANGMs in all their glory, with their heavy weightings accounted for.
The index is up 127% over that period.
But what will we find if we break down this 127% return into “gains from the FAANGM stocks” versus “gains from every other stock in the S&P”?
It’s nothing short of a tech domination.
As you can see below, the non-FAANGM part of the S&P is up only 70% during this time-frame.
And the FAANGMs?
Up 503%.
Source: Yardeni Research
Now, though the obvious takeaway is how dominate the FAANGMs are, there’s another crucial point here.
As we just noted, the S&P 500 without the FAANGMs has returned just 71% over this period. But remember, what has the overall S&P 500 index returned?
Well, we showed that answer two charts ago — it’s 127%.
Think about that …
If the S&P is up 127%, but the S&P without the FAANGMs is up just 71%, it means that the FAANGMs have buoyed the overall performance of the S&P by a whopping 79%.
In other words, elite tech stocks are bolstering the S&P, masking the ho-hum performance of ordinary non-tech stocks.
So, if your portfolio has been lagging the S&P and you don’t own the FAANGMs or an index fund with heavy tech exposure, well, now you know what’s behind your underperformance.
***This hyper-concentration isn’t limited to the S&P 500
The Nasdaq 100 actually contains 103 stocks. It’s purported to be an index of the largest non-financial companies listed on the Nasdaq. This means it holds stocks from sectors including retail, biotechnology, industrial, health care, and others.
But what’s happening in this index when we lift up the hood?
It’s a near-pure-play FAANGM fund.
Below are the top 10 holdings of the Nasdaq 100.
Only PepsiCo isn’t a tech stock.
When we do the math, it turns out that the FAANGMs make up 47% of the Nasdaq 100 (compared to the 26% FAANGM weighting in the S&P).
Let’s do another return comparison using the same beginning date as above (12/28/12).
We’ll look at …
- the FAANGMs
- the Nasdaq 100 (with its 47% weightings on FAANGM stocks)
- the Nasdaq 100 equal weight index, which gives equal return-representation to every stock in the index
- Pepsi (since it’s the largest non-tech stock in the index)
Well, you already know how what the FAANMGs have returned: 503%. But in the chart below, you’ll see the others.
The Nasdaq 100, including its heavy FAANGM weights, has returned the most, at 305%.
The Nasdaq Equal Weight index has returned 224%.
And good ‘ole, non-tech Pepsi?
A respectable, but badly-lagging, 144%
So, is your portfolio lagging “the market”?
Perhaps now you know why.
***It’s not just the broad indices that have become tech proxies
Let’s look at the ETF, XLY. It’s the Consumer Discretionary Select Sector SPDR Fund.
“Consumer discretionary” refers to companies that tend to perform better when consumers have extra money to spend and feel confident about their financial future. This is as opposed to consumer staples that are purchased regardless.
XLY holds lots of big-name brands including Home Depot, McDonalds, Nike, Starbucks, and Target.
It also holds Amazon …
How much Amazon, to be exact?
Almost 25% — which is nearly double its second largest holding.
So, you’re a Starbucks shareholder wondering why you can’t beat a broad sector fund like XLY?
This explains it.
Below, we compare Starbucks, XLY, and Amazon here in 2020.
Starbucks is down 13%, XLY is up 8%, and Amazon is flying high with 64% gains.
***The importance of tech to help fuel your own portfolio’s gains
As we look forward over this new decade we’ve just begun, the divergence of returns between “tech” and “non tech” will only widen.
To illustrate, consider how the coronavirus has changed the way corporate America does business practically overnight.
Being in the office is no longer required thanks to videoconferencing companies such as Zoom. But even when the world returns to normal, many companies have indicated they will continue with remote work enabled by tech as a permanent feature.
Now, what might this mean for the demand for, say, commercial property leases?
And by extension, what might that mean for, say, an investor in a commercial property REIT?
Boston Properties is one of the largest REITs in the nation, investing in commercial real estate in Boston, Los Angeles, New York City, San Francisco, and Washington, D.C.
Below, we see its performance here in 2020 compared to Zoom’s stock, and the Nasdaq 100, which as you know, is 47% “FAANGM.”
The divergence is nothing short of breathtaking.
Zoom is up 265% … the FAANGM-heavy Nasdaq 100 is up 21% … and the commercial REIT, BXP, is down 32%.
If you want to learn how to protect your portfolio from this dynamic — and actually align yourself with the elite tech that’s surging, I’d strongly encourage you to watch this research video from our own macro specialist, Eric Fry. It dives into the growing divide between the stock market “haves” and “have nots” that’s being driven by tech.
As significant as this divergence is today, it will only increase from here as the 2020s unfold.
Circling back to the top of this Digest, if you’ve been frustrated that your portfolio is lagging the broad market recovery, perhaps we just uncovered the reason.
Have a good evening,
Jeff Remsburg
