"God save me from fools with a little philosophy. No one is more difficult to reach.” -- Epictetus in Discourses September 12, 2020
2020. Am I right? I’m sure you’ve been desperately awaiting my views on Covid-19, Dr. Fauci, Trump and Biden, BLM, Antifa, QAnon, the U.S. Postal Service, Kanye West, the California fires, lockdown math, the death of Mr. Peanut, and murder hornets. As much as I’d love to share my highly-considered views on these matters, there is a 99.937% chance in the current environment that at least two of my opinions would offend any random reader and result in a blistering attack on my intelligence, character, and/or gene pool. Given the heightened sensitivity of the times, I’ve entrusted my opinion on these matters to a very select few, two of whom are nonjudgmental canines. The three humans on the list have known me for an extended period and already think I’m a bit of a plonker, thereby limiting further risk to my reputation. I’ll embark on a safer pictorial journey instead and explore what it means to be invested in the “U.S. stock market” at the present time. How offensive could that be?
The Wilshire 5000 Index tracks all U.S. equity securities with readily available price data, currently 3415 stocks. That’s a pretty good approximation of the U.S. stock market. Interestingly, it’s called the “5000” because that’s about how many stocks existed when the Wilshire 5000 was created. I can’t access the detailed breakdown of the Wilshire 5000, but I can get the weightings for the similar CRSP U.S. Total Market Cap Index, which tracks 3495 stocks. You could even get real-world exposure to this broadest definition of the stock market by buying the Vanguard Total Stock Market ETF (VTI), which tracks this CRSP index. What exactly would you own though? The CRSP Index, the Wilshire 5000, and VTI are all capitalization-weighted. This means that every company in the index is weighted by size. The larger a company’s market value, the larger its weighting in the index. Even though there are 3495 stocks in the entire U.S. stock market, the market value of the largest 10 stocks account for an astounding 23% of the total. By comparison, if you start from the bottom, you’d have to add together the smallest 3262 stocks to get another 23% weighting. The performance of a mere 10 stocks is as meaningful to the entire stock market as the combined performance of 3262 stocks!
The S&P 500 index is the granddaddy of U.S. stock indices and the most common proxy for the U.S. stock market. It’s composed of 500 of the largest and highest quality stocks out of those original 3495 companies. The chart below shows that the 5 biggest stocks in the S&P 500 account for 23% of the entire index. Five! The prior cycle high was at the peak of the 2000 bubble, and that maxed out at a quaint 19%. Notice what happened to this concentration after the 2000 bubble popped.
It should come as no surprise then that the performance of the entire S&P 500 is driven by a small number of stocks. The next chart shows that only 10 stocks accounted for over 50% of the S&P 500’s return in August. These giant companies aren’t just in the S&P 500 and Wilshire 5000. Microsoft, for instance, is in the Dow Jones Industrial Average, the Nasdaq 100 Index, the S&P 100 Index, and the NYSE ARCA Major Market Index. In addition, MSFT is owned in 415 exchange-traded funds (ETFs). These huge companies have proliferated faster than a lab-generated bat virus (too soon?).
The next couple of charts further highlight the importance and impact of just a handful of the largest of the large stocks. The first chart splits out the 10 largest growth stocks in the S&P 500 for 2020. If you leave out these 10 names (the lighter line on the bottom), the index looks rather pedestrian and is actually down for the year. It’s the 10 largest growth stocks (top line) that account for all, and then some, of the S&P 500’s performance this year. These 10 stocks were all that mattered.
The next chart carves out the 5 largest stocks from the S&P 500 and looks back to 2015. What a huge difference between the S&P 500 and the S&P 495! Once again, the performance of "the market" has really been driven by just a few stocks. Recall from our second chart above, these 5 largest stocks have grown from under 13% of the S&P 500 in 2015 to 23% today. Investors have flocked to these few names at an increasing pace in recent years, especially since the 30% drop this past March.
This infatuation with the biggest and supposedly safest stocks is very similar to what we experienced during the 2000 bubble. As smaller stocks faltered, investors rotated into the largest names instead of abandoning stocks altogether. This extended the bubble a little bit longer, but the outcome was never in doubt. Almost everyone thought Cisco, Intel, and Microsoft were very safe investments at the 2000 peak. Cisco was the “mature” poster child of that bubble. It plummeted nearly 90% from peak to trough.
The other similarity with the 2000 peak is the late arrival of retail investors (that’s you). We’ve seen a dramatic increase in new retail account openings at every brokerage this year, with Robinhood leading the pack as the preferred platform for the millennial generation. These retail investors aren’t sitting on their hands. There are Joneses to keep up with! The chart below shows that retail trading activity has exploded this year. As is typical of every bubble, the retail investor is late to the party and arrives right before the riots begin (too soon?). In the meantime, however, this latest bubble is once again helping the little guy feel more confident, more intelligent, more talented, and more attractive. I can practically smell the testosterone wafting from my neighbors' basements on my daily jog.
The second chart illustrates another key shift in the stock market. From 1940-1980, investors bought and held stocks for 3-8 years on average. Investors were actually…you know…investing. This holding period has dropped steadily since the mid-1970s and now stands at less than one year. The stock market is no longer for investing. It’s a tool for speculation. It’s little wonder that few investors know how to analyze a financial statement these days. What's the point if you're just a tourist or renting instead of owning?
The next chart shows the growth in the total number of stock positions at Robinhood. The data is a few months old, but you can see the sharp ramp in activity right as Covid-19 lockdowns were taking effect, stimulus checks were being cashed, and the stock market was undergoing a furious rally from the March lows. Retail investors are cutting the line for their next beating.
Our final chart breaks down the type of trading occurring in the market today. See that cute highlighted sliver of 9.9%? That’s us! Actually, our “kind” makes up just a fraction of that fraction. The other categories may be hard to comprehend, but the key point is that stock trading is being overwhelmingly driven by speculation, indexing, options trading, and short-term computer algorithms. Very few of those transactions are concerned in the slightest with how overvalued or undervalued a company’s stock may be or whether a company is viable or fraudulent. In the short-term, this encourages bubbles, but it also sows the seeds of its own destruction and will exacerbate corrections and bear markets when momentum shifts.
The Long And The Short Of It
The popularity of index investing and the herding of retail investors has caused a fascinating feedback loop in the market. Investors buy index funds and chase after the biggest and best performing stocks which pushes up the S&P 500 which leads investors to believe that the stock market is risk-free, so they buy more index funds and the biggest and best performing stocks which pushes up the S&P 500…and on it goes. Left out of this piece has been any substantive discussion of valuation. Is the stock market ridiculously overvalued? Of course. We’re at or near record valuation levels based on just about any predictive, historic valuation metric. Does it matter today? No. Will it matter at some point? Of course. There are arguments made during every bubble as to why “it’s different this time.” Can you name one bubble throughout history which hasn’t popped? Does anyone really think that human nature, mean reversion, the laws of supply and demand, and the principles of elementary math have been repealed?
Hopefully, this helps explain a little better why I have no interest in owning “the market” at these levels but can still be very bullish about select stocks and sectors. There is no monolithic market. There are a handful of huge and grossly expensive stocks driving the market, and then there are the other 3450 stocks. Within those other 3450, there are some tremendous values and bargains, and we own some of them. It’s that simple.
To sum up this piece, there are millions of out-of-work and work-from-home types spiking their ayahuasca with crushed Adderall as they day trade stocks they know nothing about on their iPhones while posting pics of their Starbucks latte to their Instagram pages for their 7 followers (including an account they set up for their goldfish that died 3 months ago) from the back of an uber in the hopes of moving out of their parents’ houses after they build their $650 nest egg into a cool million by the end of the month while mocking Warren Buffett as an aged, out-of-touch relic, just like their counterparts did at the top of the last two bubbles. Or something like that. There is nothing healthy about the increasing concentration of the market, or the record short average holding period for stocks, or the increasing domination of non-fundamental investors, or the predictable late awakening of the retail crowd, or ridiculing Warren Buffett, or maintaining an Instagram page for a dead fish. Greed, irrationality, and unwarranted self-confidence are in full swing. A lot of little piggies went to the market. A lot of those little piggies are stuck at home. Most of those piggies will end up with none and cry “sell sell sell” all the way back home from Starbucks. I can’t speak to the roast beef.
Best,
Ken Bell, CFA, CFP, MBA, Pig Shepherd
Aspera Financial, LLC
The Market Rubbernecker is associated with Aspera Financial, LLC, an investment management and financial planning firm based in the Cary, Raleigh, and Durham area of North Carolina. This and all Market Rubbernecker missives and musings (written, oral, or mimed) are subject to the disclaimers, disavowals, and hindquarter-coverings found at www.asperafinancial.com/aboutrubbernecker.