In my previous discussion, I highlighted the long-term performance of the equal-weighted S&P 500 ETF (RSP) in comparison to the S&P 500 ETF. Over a period of 20 years, RSP has outperformed its counterpart in most years. This achievement is attributed to the size factor, which indicates that smaller companies tend to yield greater returns than larger ones.
However, this year has been truly exceptional. The S&P 500 Index has achieved a remarkable level of outperformance, surpassing its equal-weighted counterpart by nearly 10 percentage points. This significant margin of outperformance in 2023 is the largest on record so far, as reported in a recent article by WSJ. The visual representation of this comparison can be observed through the green bars, indicating the S&P 500’s outperformance, while the orange bars depict the outperformance of the S&P 500 equal-weighted index.
This pattern of underperformance extends beyond the S&P 500 when comparing returns against small companies outside the index. For instance, the S&P 400 ETF (SPMD), representing mid-cap stocks, remained flat, and the S&P 600 (SLY), representing small-cap stocks, declined by 2%, while the S&P 500 gained 10% year-to-date.
The contrast in performances becomes even more apparent when considering the 100 largest stocks in the S&P 500, tracked by the S&P 100 ETF (OEF), which saw a 16% increase. This highlights that mega cap companies are primarily responsible for driving up the indices and the overall market, rather than a broad-based recovery.
Delving deeper into the performance of individual S&P 500 components, the largest 250 stocks yielded an average return of 2% year-to-date, while the smallest 250 stocks recorded an average decline of -4% during the same period.
The content below was originally paywalled.
A rather striking observation is that the larger the market capitalization of the stocks one invests in, the higher the returns tend to be. Conversely, adding smaller-cap stocks to the portfolio tends to result in lower returns for this year. This concentration of outperformance among big caps reveals a narrow range of companies driving the market’s performance.
Why is this happening?
One possible explanation could be that investors are gravitating towards mega cap companies due to their familiarity and reputation, assuming that these larger companies will recover faster after a market crash. However, historical data contradict this intuition, as small-cap stocks have typically shown stronger recovery post-crash. Surprisingly, in the current scenario, only the big caps have experienced a rebound while smaller caps have lagged behind by a mile.
I am not sure if this is a bad omen. The lack of a broad-based market recovery and the disproportionate influence of mega cap stocks may distort the perception that the bullish trend has fully returned. Relying solely on a segment of the market for momentum is not sustainable, potentially indicating another crash might be looming.
I may sound like Chicken Little but I think it pays to err on the safe side when the mega cap rally has been fast and furious. Taking some profits off the table could be a prudent consideration, without necessarily exiting positions entirely.
For investors who have missed the opportunity to participate in the current rally and are contemplating investing in the successful mega caps, it might be wise to reconsider and wait for a correction before entering the market. It’s important to remember that stocks cannot maintain a continuous upward trajectory without any correction.
