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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Over the past year or so there’s been an unprecedented concentration of stories bemoaning equity market concentration. This is another one.
“Market leadership is becoming increasing unhealthy with a further increase in stock concentration this January versus last year,” says JPMorgan in its quant team’s latest US equity strategy report:
While the weight of the top 50 stocks within S&P 500 remains roughly unchanged, the largest 10 stocks have continued to increase (now at 33.1% weight) at the expense of the next 40 (down to 35.8%) and the broader index,
Cap-weighted S&P 500 trounced its equal weighted version by ~3% YTD compared to ~12% outperformance in all of 2023. This extremely concentrated setup (50-60 year high, comparable to Nifty-Fifties). intensifies the battle between index funds and active funds. In particular, it presents a high hurdle for active managers to outperform cap weighted benchmarks given the narrow opportunity set of winners tilted towards mega-cap companies.
Here’s the evidence: only 23 per cent of large-cap core funds outperformed their benchmark last year. The month-to-date performance isn’t quite that bad, but for manilla and growth funds it’s still well below the 2022 level.
Part of the problem is that investment advisors and mutual funds have been running just to stand still. JPMorgan finds the actives have been adding exposure to the ‘Magnificent Seven’ since the first quarter 2023, but their pace of purchases has lagged the increase in their benchmark weight.
“Based on our estimates, the negative active weight for institutional investors in Mag7 increased further to ~-3% versus the S&P 500 index composition in 3Q23,” JPMorgan says.
Another interesting finding is that among active managers, not all of the Mag7 are considered equal. Meta and Alphabet are consensus longs. Everything else is an underweight, particularly Apple:
. . .whereas retail takes more of a fill-your-boots approach:
Where does that leave active management? In trouble is where, says JPMorgan:
Even though Mag7 represents 29% of index weight within S&P 500, their share of total expected 2024 earnings is at 21%. However, of the expected earnings growth this year, their contribution is far more significant at 34%. If stock leadership remains narrow in 2024, active managers may find themselves in a vicious cycle of again having to compete with momentum chasing index funds and being forced to chase an even more concentrated benchmark.
Wasn’t 2024 meant to be a stock-picker’s year?
Further reading
— What exactly is your problem with stock index concentration? (FTAV)
