We’ve dipped our toes into Q2, 2023. After a rotten Q1 you could say things were bound to go up. At some point. But what’s struck me as super curious is that while banks were busy getting hammered the stock market fell (which makes sense, obvs) but then rallied. Why on earth?
These past few weeks have been nothing short of crazy. We had 2 banks go bust in 2 days – Silvergate and SVB (read about that collapse here and why you should care).
Then, as if things couldn’t get any worse we had an arranged marriage between Credit Suisse and UBS! This marriage was forced so that a globally important bank like CS wouldn’t drag down the entire system with it. Fair enough.
Rates up, stocks down?
We’re seeing this damage thanks to interest rates who have been dragged off the ground and hiked to above 4% in just 12 months. Something, somewhere was gonna break at some point. We’ve been addicted to 0% interest rates (aka free money) and taking this drug away was bound to produce some really nasty side effects.
But the recent action we’ve seen in the broader stock market has caught my eye. Lemme explain.
The S&P 500 fell around 7.6% in March. Given the stress and uncertainty markets were facing, this is no surprise. But then something interesting happened: from 13 March till now, it’s gone up by ~7.5%.
Is the market telling us something we’re just not seeing?
When the market goes up, you gotta look under the bonnet. It’s not always what it looks like.
These juicy green returns we’re seeing came from just a handful of stocks. In other words, the gains were not coming from the crowd. But from the few individuals.
Microsoft and Apple together contributed more to the S&P 500’s gain in the past few weeks than ALL the financial stocks have lost. The 5 biggest companies in the S&P 500 account for roughly 23% of the index.
But regional banks – where all the problems came from, who have seen share prices drop like mad (First Republic lost 90% of its value in 1 month) don’t account for more than 0.4% of the index!
It’s the strong against the weak.
While the little guys fell and injured themselves pretty badly, the big guys got bigger. Healthier, fitter and stronger.
The poor side to passive investing
Because the S&P 500 is weighted by market cap, the largest stocks have the biggest impact on the index both in driving the long term performance but all also the short term moves.
Crazy stat: the 10 biggest stocks make up 27.35% of the index!
This means that as an investor – you should get comfy with these 10 giants if you want to understand what’s driving the market but more importantly, what you’re actually investing in! (Psst: read here how to fund your future with the smallest sums).
A bunch of people I’ve talked to who hold the S&P 500 think they’re getting equal exposure to these 500 companies. They think they’re equally exposed to sector/size ect. But that’s just not the case.
Investing in the S&P 500 means you’re taking a punt on the 10 biggest guys. Not the 480 small ones. In reality, they won’t make that much of a difference to your overall return.
Look at the top 10 biggest companies in the S&P 500 and what % of the index they make up:
1. Apple (APPL) – 7.13%
2. Microsoft (MSFT) – 6.16%
3. Amazon (AMZN) – 2.67%
4. Nvidia (NVDA) – 1.98%
5. Alphabet Class A (GOOGL) – 1.87%
6. Alphabet Class C (GOOGL) – 1.64% (don’t get confused – the difference between the 2 classes: Class A trades for higher than C and carry more voting rights, that’s all!)
7. Berkshire Hathaway (BRK.B) – 1.64%
8. Tesla (TSLA) – 1.56%
9. Meta Platforms Class A (META) – 1.35%
10. UnitedHealth Group (UNH) – 1.35%
Looking at the top 10 you can probably guess where I’m going with this! They’re not evenly spread out across a bunch of different sectors like you’d expect from a diversified passive investment. Nuh-uh.
The top 10 are mainly tech companies!
When tech rallies, the market rallies. Simple as that. They’re just so big that they have a whopper impact on market moves.
This is the risk of passive investing. The concentration. The index is concentrated towards the biggest companies. The index ends up being over-exposed to just a handful of stocks/sectors.
The big guys dominate the index.
When you buy the S&P 500, you’re basically buying into America’s largest 500 companies. Sounds great. You think you’re nice and diversified which means your risk is lower blah blah blah.
But if you actually look closer you’ll see that the majority of your exposure comes from just a handful of companies.
So when you invest in an index the S&P 500 or any other one really, have a look at its top holdings. See what companies/sectors really dominate the returns. That should help you decide whether you want to be over/underweight a particular index.
The problem with passive
For more than 100 years – despite wars, bear markets and all the rest of it, stock markets offered positive long-term returns. Depending on which index you invested in, your average returns ranged from a few percent up to about 10% or 11%. The S&P 500 for ex managed to average 8% return since 1957!
But averages can catch you out. Making an average of 10% per year doesn’t mean your stocks will go up 10% every year! The returns will vary. Massively. Some years are amazing but some might see you lose 50% of the value!
It can take decades for the index (or stock) to reach its previous high after falling so much. And even with a 10 or 20 year holding time, it’s possible a person could lose or make very little money over the time they intend to hold their investment.
In bear markets, the love for passive products can be a problemo. As more money get chucked into these funds, more and more cash is pushed into the same stocks in the index.
This makes the price of stocks in the index way higher but it also means the fall will be just as high. Or shall I say, low!
So don’t invest blindly. See what’s really going on and ask yourself if that’s what you’re expecting!
Nothing is ever guaranteed.
The best you can do is increase your holding period and to invest consistently.
That way you don’t get jittery when markets fall.
Disclaimer: This blog is not investment or financial advice. It is my opinion only. This blog is not a personal recommendation to buy/sell any security, or to adopt any such investment strategy. Always do your own research before you commit to any investment