Nov 11, 2020 Investment Question of the Month: Large Cap Tech Stock Dominance

Large technology stocks continue to dominate the market. Is this a new normal?

The top 5 stocks in the S&P 500 – Apple, Amazon, Microsoft, Alphabet, and Facebook – have had an extraordinary run of returns. Year-to-date through August, the S&P 500 index returned 10% – with those five stocks returning 49% while the remaining stocks in the index returned -3%[1].

Many have wondered if we can expect these stocks to continue to exhibit strong performance going forward. Looking at the companies who have been at the top of the market in the past can provide helpful insights to inform our expectations for the future.

Exhibit 1 shows a breakdown of the largest U.S. stocks by decade going back to the 1930s. One key takeaway from this visual is that we have seen this before. AT&T was among the top two for six straight decades beginning in 1930. General Motors and General Electric ranked in the top 10 for more than 50 years. IBM and Exxon were also mainstays in the second half of the 20th century. In recent years, a concentration of the stock market in a few large companies such as the FAANG stocks is not unprecedented[2].

Exhibit 1

It is also not unprecedented for disruptors to be at the top of the market. While the definition of “high-tech” is constantly evolving, firms dominating the market have often been highly innovative. Dupont, the inventor of Teflon and Nylon, two household items that many individuals use daily, was at the top of the stock market for several decades after these two seminal inventions. AT&T is another company that spent several years dominating, as they brought the first mobile telephone service to the market. Technological innovation dominating the stock market is not a new normal.

Should we expect these growth stocks to continue such strong performance going forward? Truth be told, no one knows the future, but historically six of the nine decades going back to the 1930s, value stocks have outperformed, and over the full period, value stocks outperformed by 3.2% annualized[3].

Furthermore, Exhibit 2 shows from 1927 to 2019, the average outperformance of the largest ten stocks over the three years prior to joining the Top 10 was nearly 25% higher than the market. In the three years after, the edge was less than 1%[4]. Five years after joining the Top 10, these stocks were, on average, underperforming the market. Extend the time frame out to 10 years, and the gap was even wider – a stark turnaround from their earlier advantage.

This chart is illustrative of the concept that once a company is large and dominant, sure, it may stay at the top of the market, but this does not necessarily mean it is also a great investment. Rather than chasing today’s top companies’ performance, we want to ensure we are well-positioned to capture the returns of tomorrow’s top companies. While it remains impossible to predict which companies will outperform the stock market, we can focus on controlling what we can by having broadly diversified portfolios that provide exposure to a vast array of companies and sectors.

Exhibit 2

Note: Companies ranked by USD market cap at the beginning of each decade. Data from CRSP.

1 Ten Largest companies by market capitalization

 

 

 

 

IMPORTANT DISCLOSURES

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced herein is historical in nature and is not an indication of or a guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any strategy or investment will prove profitable.   As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility, therefore.

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. This newsletter should not be regarded as a complete analysis of the subjects discussed. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy. The fast price swings in commodities and currencies can result in significant volatility in an investor’s holdings. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily consider the particular investment objectives, financial situations, or particular needs of all investors. For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.

Index Definitions

Fama/French US Value Research Index provided by Fama/French from CRSP securities data. Includes the lower 30% in price to book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973).

Fama/French US Growth Research Index provided by Fama/French from CRSP securities data. Includes the higher 30% in price to book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973).

Fama/French Total US Market Research Index: The value-weighed U.S. market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American Depositary Receipts

 

[1] Top 5 Stocks in the S&P 500 Index defined by market cap: finance.yahoo.com.

[2] None of the names mentioned or in the exhibit are recommendations to buy or sell. Past performance may not be indicative of future results.

[3] Difference between the Fama/French US Value Research Index and the Fama/French US Growth Research Index

[4] Source: Dimensional, using data from CRSP, includes all U.S. common stocks excluding REITs. Largest stocks identified at the end of each calendar year by sorting eligible U.S. stocks on market capitalization returns are measured as the start of the first calendar year after a stock joins the Top 10.

 

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Important Disclosures

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein and take no responsibility therefore.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.