An investor can buy the SPY Exchange Traded Fund (ETF) and get broad exposure to the 500 largest companies in the United States at a very low cost. State street offers the (SPY) with an expense ratio of 0.0945%. Vanguard offers the (VOO) for an expense ratio of 0.03%. Today, the top 5 companies in the S&P 500 make up 23% of the entire index. You know the names and use their products, Apple, Amazon, Microsoft, Facebook and Google. These are great companies that have produced good earnings. All 5 have benefitted from the “stay at home” economy. These 5 stocks are driving the performance of the stock market as measured by the S&P 500 as shown in the chart below.
Barry Ritholtz puts some perspective on the market vs. the economy in his article, “Why markets don’t seem to care if the economy stinks:”
“The economy many people experience, while bleak, is local, personal and, for the most part, either not publicly traded or plays only a small part in the stock market’s moves. To explain why these personal experiences have so little effect on equity markets, we must look more closely at the market role of the weakest industry sectors.
The surprising conclusion: The most visible and economically vulnerable industries are also among the smallest, based on their market-capitalization weight in major indexes such as the S&P 500. Markets, it turns out, are not especially vulnerable to highly visible but relatively tiny industries. The 30 most economically damaged industry categories could be de-listed before tomorrow’s market open, and it would hardly shave more than a few percentage points off the S&P 500.
He continues later in the article:
“Year-to-date (as of the end of July), these include department stores, down 62.6%; airlines, off 55%; travel services, down 51.4%; oil and gas equipment and services, down 50.5%; resorts and casinos, down 45.4%; and hotel and motel real estate investment trusts, off 41.9%. The next 15 industry sectors in the index are down between 30.5% and 41.7%. And that’s four months after the market rebounded from the lows of late March.
So although high visibility industries may be of considerable significance to the economy, they are not very significant to the capitalization-weighted stock market indexes.
Consider how little these beaten-up sectors mentioned above affect the indexes. Department stores may have fallen 62.3%, but on a market-cap basis they are a mere 0.01% of the S&P 500. Airlines are larger, but not much: They weigh in at 0.18% of the index. The story is the same for travel services, hotel and motel REITs, and resorts and casinos.”
If the best place to be for the last 10 years was just be in US Large Cap stocks which is the S&P 500, why wouldn’t an investor buy that and not worry about it?
Recency bias is when investors place a greater important on recent events and give less weight to events that happened in the more distant past.
What would have happened if you were invested solely in the SPY over the “lost decade” from 2000-2009. The S&P 500 Index over this decade averaged negative .95% per year. The chart from Dimensional Funds shows the performance of the S&P 500 vs other asset classes during that time.
According to the above chart, a diversified portfolio did not experience a lost decade from 2000-2009. If an investor has a sensible asset allocation for their goals, they will not be reliant on one particular index, and in the most recent case just 5 companies.
Two of the core holdings of our Global Balanced Advisor portfolio, T. Rowe Price Capital Appreciation and First Eagle Global had returns of 9.28% and 12.36% per year on average, respectively from 2000-2009. T. Rowe Price Capital Appreciation has a mix of stocks and various fixed income asset classes. First Eagle can invest outside the United States and has a position in gold. This versatility and diversification allowed those funds to achieve positive results, while over the same period of time the S&P 500 index averaged -0.95% per year on average.
The biggest technology stocks have driven performance for a long time, especially this year. Going forward, future results of the index will be heavily reliant on those companies. Things change over time as illustrated by the chart below from visualcapitalist.com:
Exxon Mobil was the biggest company in the S&P 500 in 2010, it was the 5th biggest in 2015. Apple added the market capitalization of Exxon Mobil in one day last week! I am not saying these companies are doomed or will not continue to be great. I am saying it is too easy to think what has been happening in the past is what will continue to happen. The next decade may look different than the previous one.
We own the SPY in two of our discretionary portfolios. We feel that holding has a role to play in a diversified portfolio and we have benefitted from the performance of these large technology companies. It is just one piece of the puzzle. An investor must know what they own and why they own it. As of this writing (August 4th 2020) our discretionary portfolios, the Global Balanced Advisor, Growth Equity Portfolio, and Diversified ETF portfolio have positive performance for the year.
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