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Year-to-date, the S&P 500 has returned 12.8%. On a headline basis, this is great news given all the risks out there including a slowing economy; lower, but still elevated, inflationary pressures; credit contraction; high rates….and that’s just the headline risks.
One would think a 9.6% return through May would mean we’ve recovered a lot since 2022’s bear market. But if we look under the surface, the numbers tell a different story. Let’s start with the equal-weighted S&P 500, which is down 0.65% year-to-date (YTD). Unlike the S&P 500, the equal-weighted S&P 500 does not give extra contributions based on market-capitalization. In broad rallies, the equal-weighted index is not that far behind the headline S&P, so what’s driving this variance in 2023?
Looking at the make-up of the index, Technology, Communications, and Discretionary sectors make up 47% of the S&P 500 and have YTD returns of 34%, 33% and 10%, respectively. The remaining sectors? All negative YTD returns. These three sectors have contributed 126% of the S&P 500’s return YTD with the Tech sector alone contributing 83% of the S&P’s return.
So, we know that the technology-oriented and growth-related stocks are driving the return. This leads us to what I like to call the Big 7 names (30% weight in the S&P 500). The Big 7 include: Microsoft, Amazon, Alphabet, Meta (Facebook), Tesla, Nvidia, and Apple. These 7 names have driven the S&P’s YTD return with a contribution that is 115% (11.1% aggregated YTD return) of the S&P’s 9.6% return.
The aforementioned numbers are what make this rally a bit of a head fake. While the headline number is great and we’re certainly happy markets are up, we’re also mindful that the optimism is not necessarily across the board. This makes news headlines of a new bull market a bit stretched given 55% of the S&P’s names, but only a 40% weight, have negative YTD returns. Now, not everyone needs to have a positive return for things to be doing well but it certainly helps from a sustainability perspective if both the large and small names are doing the legwork.
It is worth pointing out that while Healthcare and Utility names have traditionally been seen as defensive, the Big 7 are not speculative, growthy names being priced for optimism 10 years later (Tesla is a bit of an outlier though). The Big 7 have a significant market share in their industries, strong management teams, sustainable cash flow and low earnings variance, alongside very large economic moats and have cash balances that would make Janet Yellen jealous. In an uncertain environment like we are in, it makes sense to follow the names that can sustain themselves in a downturn, essentially playing defense by owning the largest of the large in the equity markets.
What would get us optimistic about equity markets, then? In order to have more confidence in the market rally, we’d want to see small-cap stocks start to lead the S&P. At the end of May, the Russell 2000, a small-cap stock index, returned -0.06% YTD. There are many other indicators that we could point toward, but this is one that could give an early signal of a potential broad market breakout and has traditionally been associated with sustained market upswings.
So, how does an investor get excited when only a handful of names are really driving the positive S&P 500’s return, especially if they don’t hold those stocks? Though technology-oriented stocks and sectors make up a big portion of the index, and with the Big 7 totaling a 30% weight, a longer-term view may offer those more diversified investors a sunnier perspective. Since 2014, the rest of the index has contributed an annualized 6.8% vs 3.6% for the Big 7. Not to mention, on a yearly basis, the rest of the index has outperformed the Big 7’s contributions in both 2022 and 2021. So, while the Big 7’s current 115% contribution to the S&P’s YTD return is tough to swallow as the rest of the index treads water, over time the rest of the index has proven to pull its weight.
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