Looking solely at the headline numbers, the year 2023 has been very good for stocks till now. The S&P 500 Index is up almost 8% with more than 7 months still to go. Considering that the average market return over the past 20 years is about 9%, this is a nice return. If the market continues like this to the end of the year, we outperform this two-decade average return by 100%.
But something seems not right about this year’s stock market performance. Looking a bit deeper into the performance figures we realize that actually only a handful of the largest stocks are carrying the entire market. In fact, the 10 largest stocks in the index accounted for 70% of the S&P 500 Index’s gain through the first 3 months of 2023 while the rest contributed only about 30%. So, of the 8% gain the S&P 500 has seen this year, the top 10 stocks contributed around 6% and the other 490 stocks contributed only about 2%. With other words, you have a 1:49 chance that the S&P stock you invested in is actually underperforming. That makes the current market rally one of the narrowest in history.
With so much of this year’s gain concentrated in a handful of stocks, this market is extremely top-heavy. And that makes it vulnerable to collapse. Even, if we would consider that these big companies carrying the market are excellent long-term investments, they are expensive based on their price-to-earnings (P/E) ratios as most of them have a P/E ratio that is significant higher than the S&P 500’s ratio of 24.
So, when investors inevitably pull money from expensive stocks to start looking for cheap stocks again, many of the largest stocks will fall out of favour. And due to their market size the index will fall faster than the broad market.
Sven Franssen