In my podcast dated June 9, 2023 entitled "Bad Breadth", the phenomenon illustrated in the accompanying chart was discussed. This market dynamic has continued since then. The chart reveals the divergence in performance began somewhere around the time of the most recent banking crisis, which was led by Silicon Valley Bank's demise. The panic that had subsequently swept through the U.S. stock market following those bank failures has seemingly favored the highest market capitalization companies in the S&P 500. Familiar brands and market leader names erroneously became a safe haven for equity investors.
The basic S&P 500 Index is a market capitalization (market cap) weighted index of the 500 largest companies in the U.S. Currently, the Top 10 companies in the S&P 500 Index (as weighted by market cap) represent more than 30% of the total index value. That is a tremendous amount of concentration risk. Furthermore, when examining the underlying earnings fundamentals of these same Top 10 companies, we noticed that although they may represent about 30% of the total market cap of the S&P 500, they have only contributed about 20% of the last 12 months' earnings in the S&P 500, and have mediocre 5-year EPS growth rates.
As a result of this embedded distortion, our portfolio strategies have no explicit S&P 500 (market cap weighted) index exposure. Instead, we favor an equal weight approach, where all 500 companies are held in roughly the exact same percentage. This eliminates the concentration risk embedded within the traditional market cap weighted index. An equal weight approach may prove very beneficial once market participants understand that high stock prices are only justified when a company's underlying earnings fundamentals are correspondingly supportive.