Stocks fell on Friday as concerns rose that the spreading coronavirus would escalate into an event of meaningful economic consequences. This morning, futures point to further declines. Whether the virus reaches the point where it significantly impacts world economies remains an open question. But a market that has gone too far, too fast doesn’t need a major excuse to pause and correct.
Look carefully at the chart below. If you do, you will see a handful of spikes up followed by a handful of spikes down. This is a 25-year chart that captures what happens when just a few big stocks dominate a market. Some of those spikes up can last many months, even a year or more. There is a spike up beginning in 1998 that lasts into 2000. There is one that lasted about 6 months in 2007. A spike that began in 2010 lasted until the European debt crisis erupted in the summer of 2011. And now, there is the current spike that began the day after Christmas in 2018 and is still going on.
These spikes don’t reflect rising stock prices as much as they represent the concentration of winners into fewer and fewer names at the top of the leaderboard. The chart says, for instance, that since 2013, as the stock market overall rose persistently, that the heavy lifting became concentrated in fewer and fewer names. Over the past year, as you can see from the symbols above the most recent spike, six stocks now account for over 20% of the market cap of the S&P 500. One of those six, Amazon, was the best performer up to the end of 2018 but has been a market laggard since. Berkshire Hathaway, another of the top 6, has been a steady gainer but has not been outperforming the overall market. Thus, in the most recent rally, the real leaders have been Alphabet#, Apple#, Facebook# and Microsoft#.
If you as an investor, retail or institutional, had a goal of outperforming the S&P over the past several years, it would have been quite hard to do without owning the six stocks noted. Over the past six months, you would have had to own, Apple, Alphabet, Facebook and Microsoft. Not only would you have had to own them; they would have had to comprise more than 20% of your overall portfolio or more, to give you an advantage versus the overall market.
But let us not forget that the world moves in more than one direction. Remember the laws of gravity that say what goes up must come down. Right now, money is flooding into ETFs. Some of that is momentum chasing. Some is new pension and retirement money coming from bonuses or employer contributions. But don’t get too complacent. A few disappointing earnings reports, a Trump tweet that markets don’t like, or maybe a new virus floating across the Pacific Ocean can suddenly make permabulls skittish. That could be happening as you read this note. One or two wiggles down could suddenly cause a flood of profit-taking. If that were to occur, and investors sell their S&P 500 ETFs, guess which stocks will have to be sold the most. The six just listed. That is why the spikes down in the chart are just as sharp or sharper than the spikes up.
Look at the chart again. Look for any upward spike, even the small ones. On the way up momentum chasers buy the winners. Over time there are fewer and fewer of them. Finally, momentum is exhausted and the engine goes into reverse.
There is no way to pick the top, the point where momentum runs out. It could be today or months from now. But do understand that part of the reason Apple, Alphabet, Facebook and Microsoft are doing so well right now relates to the concentration of leadership within the S&P 500. All this doesn’t say the four are bad stocks to own. Over time, earnings growth matters and all four are projected to have fine years in 2020. But valuation matters too. In June, Apple’s stock was below $200. Today, it is over $300 and earnings growth isn’t the reason.
When the Big 4 are outperforming the market, they are the stocks to own. When they are underperforming, they are the stocks to avoid. I don’t know when the next correction will be. But you can see from the amplitudes that the current concentration is pretty extreme when viewed over the last 25 years. If six stocks are going to go from 20% of the S&P 500 back to 17%, the only way that can happen is for them to underperform over some period of time. That could simply mean they go up less. That’s underperformance. You could argue that if their earnings collectively grow faster than the market, they should account for a bigger percentage of total market cap over time. But go back and look at the top six names from 2000. Only one, Microsoft, has outperformed over the last 20 years. Cisco# and GE actually trade for less today than they did 20 years ago. Intel is about the same price.
Realizing profits and paying taxes isn’t fun. But taking a bit of money off the table occasionally makes good sense. Don’t be a pig. Don’t think you can get out at the exact top. Maintain balance within your equity holdings and pay attention to your asset allocation. Such a strategy will pay off in the long run.
Today, actor Alan Cumming is 55.
James M. Meyer, CFA 610-260-2220