The cap-weighted S&P 500, dominated by fast-growing tech megaliths, has many wondering if its unbalanced nature will tip over. Can chipmaker Nvidia, up 79% this year and 0.5% on Friday, with a towering 75 price/earnings ratio, continue its upward march?
Examples like that are why the equal-weighted S&P 500 index is getting a lot of attention these days. Here, top-weighted Microsoft, with its 7.4% share (Nvidia, the fastest grower, is No. 3) is counted as the same as the smallest stocks in the index, like No. 500, Bio-Rad Laboratories, at 0.01%. No surprise, the equal-weighted index is up just 3.7% this year, versus the traditional cap-weighted alternative, at 16.6%.
The trouble with pivoting to the equal-weighted index, as a way to hedge tech slowdowns, is that it may not be any safer than the cap-weighted index. In fact, evidence exists that equal-weighting delivers subpar returns over time.
A study by Sam Stovall, chief investment strategist at CFRA Research, showed that equal-weighted indexes typically endured deeper selloffs and reduced frequencies of outperformance than their cap-weighted cousins during market declines of 10% or more for the S&P 500 (since 1990), Nasdaq-100 (2007), Russell 2000 (2000) and S&P SmallCap 600 (2011).
History shows “that the collective approach to investing has frequently not lessened the magnitude of the eventual decline,” Stovall wrote. “Prudence is not synonymous with protection. Concentration has been a major concern of this market’s outsized advance.”
As Stovall pointed out, the overweening influence of Big Tech has distorted market returns: “Now that the S&P 500’s year-to-date climb has been driven almost exclusively by a handful of tech-oriented stocks, investors have begun to quote Winston Churchill by saying, ‘Never was so much owed by so many to so few.’”
Indeed, on June 24, the market should have had a good day: 70% of the S&P 500’s stocks were positive. Unfortunately, Nvidia had an uncharacteristic bad day, slipping 6.7% and dragging down everything. The index closed 0.36% in the red.
More days like that may impel giving equal-weighting a closer look. Either way, index funds have long been important to asset allocators, based on the proposition that beating the market is very difficult. That sentiment may be changing with the advent of private assets in institutional portfolios. While there are no figures on the extent of allocator passive investing, it is notable that private investments such as real estate are actively managed, per a study by the Center for Retirement Research at Boston College.
Could such actively managed private investments become an even more popular way to hedge public markets dominated—for better or worse—by a select few? The use of indexes of all kinds may change depending on the result.
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Tags: Bio-Rad Laboratories, equal-weighted index, Index, Microsoft, Nvidia, S&P 500, Sam Stovall, Winston Churchill