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Market Commentary: November 2023 – The Normal Abnormal Market

The Normal Abnormal Market

November 2023

By Jonathan McAdams, CFA


After a rough 2022, the stock market is having a good year so far. Through the end of October, the S&P 500 is up 10.7%, which is very close to its long-term average return. Looking below the surface, however, we find that the market is anything but average this year. In fact, it has been one of the least average years in history.

As we discussed in a previous communication a few months ago, most, if not all, of the return this year in the broad indices has been driven by a select handful of the very largest stocks. We won’t belabor the points we’ve made in previous letters, but the chart below speaks to just how concentrated, or “narrow,” this year’s market performance has been. The bars represent the returns of the market cap-weighted (the traditional S&P 500 we think of) minus the returns of the S&P 500 equal-weighted index. When the bars are positive, the market cap weighted index outperforms the equal weight index, and vice versa. Think of the equal weighted index as a measure of how the “average” stock in the index has done since every stock in the index has the same weight.

You can see that we are at the widest disparity in 30 years – meaning that the very largest stocks have driven all of the returns in the index this year. We also compiled the data for the Nasdaq 100 which tracks the largest stocks in the tech-heavy Nasdaq. Results are even more pronounced than the S&P 500, but only go back 10 years.

Past stock market reactions have been muted

Source: YCharts

This performance disparity can also be seen when looking at sector returns within the indices. The far right column in the table below shows the YTD returns for all 11 sectors of the S&P 500.

Remarkably, 8 of 11 sectors are actually negative this year, with several substantially so. The aggressive move to higher interest rates has negatively affected the more rate-sensitive sectors including financials, utilities, and real estate.  And the sectors that are up?  They are dominated by the very largest tech and growth stocks – AAPL, MSFT, and NVDA together are 50% of the Technology sector, META and GOOGL are 50% of the Communication sector, and AMZN and TSLA are 40% of the Consumer Discretionary sector by weight.

What does this mean for managing portfolios?  It means that unless you owned every one of the very biggest stocks, at close to the weights they are in the index, then you are likely underperforming the market cap weighted “benchmark” this year.  In fact, the S&P 500 Equal Weighted index is down -2% year to date, indicating just how difficult it has been for the “average” stock.  And it’s not just the S&P 500.  This year, if you are invested in small or mid cap stocks, as well as dividend-focused stocks, your performance is likely down.

Source: YCharts

So why not just hold all of the big stocks in the index to avoid this?  As you can see from the S&P 500 cap weighted performance chart at the beginning of this article, it doesn’t always pay to own the biggest stocks.  Particularly in down market years, not owning the large high-flyers can actually be of great benefit (see 2000, 2001, 2009, and 2022).

In addition, owning too much of the broad, cap-weighted indices can open an investor up to concentration risk.  For instance, the top 7 stocks in the Nasdaq 100 make up 50% of the entire index, and in the S&P 500, the top 7 make up almost 26% of the index – a very high level of concentration.  This works well if those 7 stocks continue to dominate their industries, but that is not guaranteed.  The large, dominant, outperforming companies of today are not always the large outperforming companies of tomorrow.  The table below shows the top 10 market cap companies at the beginning of each decade starting in 1990.

As you can see, not only is there significant turnover of the stocks on the list from decade to decade, but the stocks marked in red under-performed the overall market from the point of their inclusion on this list until today – and some with significant declines such as GE, IBM, and Citigroup.  There are several reasons these top stocks fall out of grace, including overvaluation (Cisco in 2000), competition (Verizon, Intel), or technology displacement (IBM).  Whatever the reason, being in the top 10 today is not a guarantee of future success.

We continue to believe that broad diversification across asset classes, sectors, and styles is the best strategy over the long-term, even at the expense of missing some upside when the market gets as lopsided as it has this year.  Yes, technically the most profitable strategy at the beginning of this year would have been to simply own the 7 big tech stocks, sell everything else, and ride that wave of performance.  But this has been one of the more imbalanced markets in recent memory, and market forces have a way of self-correcting these imbalances over time.  The most profitable short-term strategy isn’t always the most prudent long-term strategy.

Shannon Dermody

Shannon DermodyTEST

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