Ask the Rational Investor: Is "big tech" too large?
Major stock market indices have recovered most of their losses for the year. In some regards, it’s not surprising, considering the incredible accommodative stance from global Central bankers.
Beneath the surface of the stock market indices lies a somewhat concerning trend of five companies: Apple, Microsoft, Amazon, Alphabet (Google), and Facebook, which represent almost 20% of the S&P 500.
Such a large concentration of a few companies pushing the stock market higher has usually led to tears. Let me explain, why.
The S&P 500 index is capitalization-weighted by its constituents. As one company appreciates, their weighting in the index then rises. Microsoft has the largest capitalization of any company, at $1.6 trillion. That is, all of their 7.6 billion outstanding shares, multiplied by the current share price of $211, is worth $1.6 trillion. This represents 6% of the entire index. If Microsoft appreciates 1% in a single day, the contribution to the total index return is 0.06%. However, if McDonald’s, which represents only 0.5% of the index with a total market cap of $136 billion, rises 1%, its contribution to the return is 0.005%, or less than one-tenth that of Microsoft.
As illustrated in the example above, if five companies represent almost 20% of the broad stock market, investors need to own these companies in similar weightings if they hope to “keep up” with the market.
Growth investors may need to be even more careful.
The same five companies in the S&P 500 Growth ETF represent over 37% of the fund! Investors are usually very cautious about having 5% of their portfolio in a single stock. In many of the growth indices, Microsoft represents 10%, Apple 9.7%, and Amazon 8%!
The party may end soon.
For several years, technology giants have been probed by regulatory bodies in the U.S. and abroad. Lately, the pressure seems to be increasing.
There are always two sides to the story, however, and it is easy to articulate why these companies should be in your portfolio. But also, be mindful of industry and stock concentration and look to reduce outsized positions.
Sources: Forbes, S&P 500, SSGA
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