Diversification or Concentration?

By Kovi Teutsch, Portfolio Manager

2020 has gotten off to one of the worst starts in recent history. Following an extremely volatile March and a strong April rally, the S&P 500 equity index is down 10.5% this year (Jan 1st - May 12th). That is the poorest start to a year, for this timeframe, since 1970, and the worst annual performance since 2008. And yet some companies are not only surviving the current crisis, they are booming.

Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Alphabet-Google (GOOG/L), and Facebook (FB) are the five largest publicly-traded companies in the US. Together they make up over 20% of the S&P 500 index, a larger percentage than the bottom 358 companies. Their combined market-cap (stock price x outstanding shares) is a whopping $5.4 trillion dollars.

Their success during the Covid19 recession may not come as a big surprise to anyone, as worldwide lockdowns and social distancing measures have kept billions of people indoors, disrupting their daily activities and routines. Web activity, social media interactions, App-store and music purchases, Amazon orders - all of these are in high demand. Together, these five stocks have contributed 2.2% to this year's performance. Take them out, and the "S&P 495" index losses an additional 5%.

Yet such a large concentration of investors' capital in just a handful of companies can cause serious risks. Diversification, a key element of risk management, has been deteriorating within the S&P 500 index - an index many investors choose in order to provide diversification to their portfolios. The last time the top five stocks made up such a large share of the index was back in the 1980s.

Another worrying indicator is the narrow 'market breadth' of the index. Market breadth is a measurement of how many stocks are increasing relative to those which are declining. So far this year, over 400 index constituents have fallen in value. Considerable narrowing has occurred before the Dot-Com crash (early 2000's), the Great Recession (2007-2009), and Black Monday (2011), just to name a few.

Finally, these five companies are all "internet"/"information technology" related, or have a large online presence. Tech continues to dominate the S&P 500 index, while some other sectors are just a small fraction of the whole. Microsoft, Apple, and Amazon are each larger than any one of the S&P 500's four smallest sectors: Utilities, Energy, Real Estate, and Materials.

So far, the market leaders of the longest bull market in history have yet to underperform in this downturn. Will their momentum continue? Are the risks to passive investors becoming too high?

Kovi Teutsch, Portfolio Manager