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The mega-cap tech run has handcuffed stock investors

  • Mega-cap tech stocks are generating outsized returns for the broader market, and that has some investors worried about a tech bubble.
  • The 2000 and 2008 corrections occurred when narrow leadership in the market failed.
  • But narrow leadership alone is no reason to attempt market timing.
  • Rebalancing a portfolio, rotating a little between sectors, is about all an investor can do, and it is especially worth considering for index fund investors who have not been paying close attention.

Investing in the worst sector every year has actually been a lousy strategy going back 10 years.
carlosbezz | Getty Images
Investing in the worst sector every year has actually been a lousy strategy going back 10 years.

There's a trend in place that is scaring the heck out of active investment managers, and it has been in force for years: The stock market, as measured by the S&P 500, is being led by a handful of mega-cap tech stocks. This narrow leadership has been a perpetual worry of investors, and I agree that it is a negative. I agree that broad-based stock participation is better. But I also think it is lousy as a timing tool for when to rotate out.

Putting it in context: The Vanguard Mega Cap Growth Index tracking ETF was up more than 20 percent year-to-date, through Sept. 15. The Vanguard Mega Cap Value Index tracking ETF was up only 5.8 percent.

The Guggenheim S&P 500 Equal Weight ETF — meaning it does not weight by market cap but gives all the companies in the index an equal weight — is up about 8 percent year-to-date. The S&P 500 market-weighted index, the one most everyone follows, is up more than 11 percent year-to- date, highlighting the outsized influence of mega caps.

Without the mega-cap stocks losing value, or the rest of the stocks playing catch-up, the spread between these two groups not only will remain but it looks to widen. So the question is: What's an investor to do with this information?

I bring this up because the bears keep harping on this like somehow it means a massive stock decline is imminent. Why? Because the last two ginormous bear markets, beginning 2000 and 2008, were led severely lower when their narrow leadership went into reverse. Investors are applying that history to today's market — everyone piling into a narrow group of stocks. It does make me a little uneasy.

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We've also seen in the past that this type of action can continue for a very long time. During the bubble days of the NASDAQ, technology grew to about one third of the entire S&P 500. Today it is about 22 percent. Do we have to go back to that former extreme before we decide to bail out of stocks? Probably not — but that's more hunch than detailed market analysis.

The smart strategy is to lighten up a little on some of the mega-caps if they have risen above what is dictated by your risk tolerance. The top five stocks in the index — which also represent almost half of the NASDAQ 100 Index — and their returns year-to-date through Sept. 15:

Not exactly undiscovered stocks. The average return for all stocks in the S&P 500 this year, by comparison, is a little more than 10 percent, according to S&P Global Market Intelligence.

On another note, about 170 of the S&P 500 stocks are negative year-to-date — the biggest losers are loaded with, but not limited to, energy and retailers. I wouldn't make a big bet on energy. My research tells me that investing in the worst sector every year has actually been a lousy strategy going back 10 years. (Back-testing shows it's been a better strategy to rotate into the second-, third-, and fourth-worst sectors.)

Outside of oil, there are plenty of down stocks from other sectors: Alaska Air, Foot Locker, AIG, Advanced Auto Parts, Akamai, AT&T, Campbell's, Cardinal Health, ConAgra, Discover, Discover Channel, General Mills, Hilton Worldwide and many more. All those lagging S&P stocks also show that this could have been an easy year to get stuck in a down stock, which would be surprising given the positive performance this year. The average is hiding the big elephant in the room: the over-reliance on a handful of mega-caps.

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Narrow leadership of the stock market is not actionable — beyond rebalancing or rotating a little — but it is observable. It's important to keep this in mind, because you'll need to watch the action in the heavyweights in order to determine your next move. Which of the following phrases describes you?

  1. I'd rather be a little light on stocks, wishing I was invested in more.
  2. I'd rather be in stocks too much, wishing I was invested less.

Investors are all in the same boat, passive and active. Crowded trades make the market more difficult. The difference? Unlike active managers, passive investors don't know it — yet. For every investor, the sooner they figure out which phrase fits them, the better off they'll be in the end.

— By Mitch Goldberg, president of investment advisory firm ClientFirst Strategy. Follow Mitch @Mitch_Goldberg

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