- Stocks that grow to command more than a 4% weight of the S&P 500 have rarely gone on to maintain that status for more than a year since 1990, according to The Leuthold Group.
- Research Analyst Phil Segner identified that Microsoft, Apple, and Amazon are breaking this historical norm amid the pandemic-induced boom in tech stocks.
- He lays out specific risks that could end the streaks for big-tech companies.
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In the norm-shattering year that is 2020, The Leuthold Group is flagging yet another trend that you can add to the list of things that would have been unthinkable in a previous era.
It’s none other than the length of time that mega-cap tech stocks are spending as the market’s heaviest weights, thanks to insatiable investor demand for companies with relative immunity to the pandemic and profit growth to boot.
At first blush, the dominance of these tech companies is not new, particularly to the myriad investors who have reaped their returns. A record 80% of fund managers say buying US tech stocks is the most crowded trade, according to a recent Bank of America survey — and they are still buying anyway, from the looks of things.
But the unique way The Leuthold Group compares the current market-share landscape to history illustrates why investors should shake off the mindset that these stocks can only go up inevitably.
Research Analyst Phil Segner recently resurfaced an esteemed group the firm calls the Four Percenters: companies that grow to command more than a 4% weight on the S&P 500.
As Segner tells it on a recent company podcast, the club has a narrow entrance and a wide exit: it’s extremely difficult for any company to grow that big and enter, but companies typically do not hang in there for very long. Only Microsoft, GE, Cisco, Exxon, Apple, and Amazon have managed to break into the elite club since 1990.
Three of these six names — GE, Cisco, and Exxon — now count as club alumni. That’s because companies only stay above the 4% threshold only for a few months and, at best, a year, according to Segner.
In other words, the 4% threshold has been a reliable warning signal that a stock was over its skis. The chart below illustrates what happened to the three alumni afterwards.
Clearly, the other three stocks are charting their own course. Microsoft’s 18-month streak in the four-percent-plus club is the longest-running, and in September, the company made up about 5% of the S&P 500. Apple has broken in several times over the last eight years but its latest entry, thanks to the market rally, is proving to be the most durable.
All told, this unprecedented market concentration is bending the norms in a manner that Segner considers unsustainable.
“That index that in almost everyone’s mind is unquestionably diversified remains extraordinarily concentrated, pretty much any way you slice it,” Segner said. “And looking at these weights and historical context tells us that the best days are probably behind the market cap tech rally.”
It is not hard to fathom why investors keep buying these stocks and apparently holding their noses at stretched valuations. Their products and services became more necessary as COVID-19 swept across the world. In a world of low earnings growth and near-zero interest rates, these stocks are providing income. And as Segner notes, an active fund manager who wishes to invest in growth stocks will be hard-pressed to find bargains anywhere.
That said, he maintains that the risks to these stocks remain palpable. In addition to a reversion to average valuations, big-tech companies risk the wrath of antitrust enforcement, such as the Justice Department’s reported plans to file a lawsuit against Google. New tax laws that crack down on offshore profits and slower demand for cloud computing also pose risks.
But the biggest of all, in Segner’s view, is the risk that higher interest rates prompt investors to revise how much they have discounted future cash flows.
For Segner, the prolonged dominance of these stocks raises concerns about how truly diversified the S&P 500 is, and what happens to the rest of the market if these companies topple over.
The tech-led September sell-off that brought the index within reach of a 10% correction was a glimpse of what that looks like. In an “extraordinarily rare” feat these days, the largest five companies on the S&P 500 lagged the index in September.
But even after that episode, big tech is still commanding the market. How much longer can that continue? Segner admits he’s previously called for the end too soon — but says it’s still a question worth exploring closely.
“We’ve been wrong on this, but it’s got to turn around at some point,” Segner said. “So brace yourselves for the next few months.”