By: Sean Gallagher, CFP®
The S&P 500 index rose 16.9% on a total return basis over the first half of 2023. If you factor in July, the index is up over 20%. After a challenging year for investors in 2022, when the index lost almost 20%, it’s hard to complain about this year’s progress. With the S&P nearly doubling the long-term average annual return in 2023, it’s easy to say the market is healthy and all companies are doing well, right?
As always, looking “under the hood” to better understand the driving forces is essential when evaluating stock market performance.
The S&P 500 is a market-cap-weighted index, meaning companies with a higher market share represent a more significant proportion of the index. Market capitalization is a company’s stock price multiplied by its total shares outstanding. As shown in the chart below, the S&P 500 is near record high concentration as five companies represent almost a quarter of the index (as of June 30th, 2023).
The chart above also shows the largest five stocks in the S&P 500 in 2000, including Microsoft, Cisco, General Electric, Exxon Mobil, and Intel. Those companies totaled about 18% of the index in 2000 but now make up less than 9% as of July 31st, 2023. Microsoft is the only remaining name in the top five of the S&P, which makes up 6.51% on its own.
While the chart shows market capitalization and not performance (although the two tend to have a similar relationship), it does show how difficult it is to predict what the top companies will be 20 years from now and the benefits of owning an index that captures all of them.
If you strip out Apple alone, the largest company in the S&P 500, you can see its market capitalization is greater than the bottom 200 companies in the S&P 500 combined. It’s also larger than the combined market capitalization of the Russell 2000, a popular US small-cap index making up 2,000 companies
To the “why don’t we put all of our money in Apple” crowd, my response would be (1) are you positive they’ll still be at the top in 20 years and (2) you already own it through the S&P 500, of which Apple makes up about 7.57%.
Considering the concentration of the S&P 500, the following chart displays the first half of 2023 indexed market returns for three different groups of stocks.
The light blue line shows the S&P 500 price return at 16%.
The purple line shows the top seven companies in the S&P 500 (five from the last chart, plus Nvidia and Tesla) at 63%.
The black line shows the remaining 493 companies in the S&P 500 at 5%.
While the performance of the top seven companies does, in part, lead to the higher market concentration, it also shows just how lopsided the S&P 500 has performed for the first half of 2023. The index’s top-heavy concentration gives the illusion that the broad market is rallying in 2023 when realistically, it’s been a handful of names driving performance. A sign of a healthy stock market would include a wider range of companies performing positively, which we are keeping our eye on for the second half of 2023.
The foregoing content reflects the opinions of Highland Financial Advisors, LLC, and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct.
Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.
Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful or that markets will act as they have in the past.
Sean Gallagher is a CERTIFIED FINANCIAL PLANNER™ at HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Sean graduated from Virginia Tech’s financial planning program in 2018 and successfully passed the CFP® national exam in 2019. As a Financial Planner at HIGHLAND Financial Advisors, Sean works on developing comprehensive financial plans and investment management for all clients.