Mega 5

The 5 Mega Companies and What That Could Mean for Markets

Transparency should be an objective for every investment account. Knowing what you own and what fees and expenses you are paying is a critical part of portfolio management. Developing a diversified portfolio is difficult when you don’t know or understand what you own.

 

Many people have mutual funds. Mutual funds are holding tanks for individual stocks, bonds, and cash type instruments. The performance is based on those underlying investments.  A mutual fund is not an investment in and of itself. You could own multiple mutual funds, yet still, hold the same underlying stock.  Not giving you the diversification you intended.

 

Prudent investors have learned the value of diversification and the challenge with mutual fund overlap – owning the same stock in varying mutual funds. A plausible answer was to buy an index fund where they “knew” all of their individual investment holdings. The S&P500 is comprised of the largest US companies and is non-managed. The index is often replicated by mutual funds and exchange-traded funds. Owners do indeed own 500 approximate companies, but there is a break in the concept versus reality.

 

The index is comprised of 500 companies, but the common way to express investment ownership is via market capitalization. The individual company’s market capitalization is vastly different and is concerning. The markets experienced a similar issue in 2000 right before the tech wreck.

 

According to Goldman Sachs, in late 1999, the five largest companies in the S&P500 accounted for 18% of the entire value of the index. Currently, that percentage exceeds 20%. That is troubling; however, there are some differences.

 

The tech wreck of the late 1990s was driven by a technology and telecommunications explosion that had a collective negative net earnings profile.  The two sectors accounted for 40% of the indices valuation. That was anything but diversification.

 

The five mega companies of today – Microsoft, Apple, Amazon, Google, and Facebook – have real earnings, and they have cash. Goldman Sachs reports that the companies added over $4 trillion in market cap since 2013. They also have EPS (earnings per share) growing at 12% year over year compared to the other 495 companies that grew at a mere 2% in the first quarter of 2020.

 

What does this mean for the markets? According to SentimenTrader, when the top five companies make up less than 20% of the S&P500 market cap, a rallying market does well.  Keep in mind that this is not necessarily the case in a declining market. Their research shows the opposite when the five largest holdings are greater than 20% of the value.  Looking one year out, during time periods where a rally existed and the top five were below 20%, the market had a positive return 100% of the time a year later. However, when over 20%, only 29% of the occurrences were positive one year later.

 

Diversification is elusive at times.  We must be diligent in our research over transparency for the sake of managing portfolio risk.  Know what you own!

 

Disclaimer: Joseph Clark is a Certified Financial Planner™ and the Managing Partner of Financial Enhancement Group, LLC an SEC Registered Investment Advisor. He is the host of “Consider This” found on WIBC Saturday mornings from 6-7a.m. as well as three other Indiana-based radio stations. Joe has served as an Adjunct Assistant Professor at Purdue University where he taught the capstone course for a degree in Financial Counseling and Planning.

Financial Enhancement Group is an SEC Registered Investment Advisor.  Securities offered through World Equity Group, Inc., Member FINRA/SIPC, and a Registered Investment Advisor.  Investment Advisory services offered through Financial Enhancement Group (FEG) or World Equity Group.  FEG is not owned or controlled by World Equity Group.

Joseph Clark and World Equity Group, Inc. do not provide tax or legal advice. For tax advice consult with a qualified tax professional. For legal advice consult with an attorney.

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