Do you know what you own, and why?

We often talk about diversification and how important savvy, forward-thinking asset allocation is to a portfolio. Sometimes, however, investors assume that holding a “passively managed” index means the same thing now as it did five or ten years ago.

In this edition of Market Update, we’ll more closely examine how the S&P 500 Index has changed over time.

Here are some things we know. We know that this is not the same economy as 20 years ago. We know that technology has created new types of industries. That from the introduction of the Sears’ catalogue, or even Ford’s assembly line, in one form or another, disruption has always been the norm.

So, for the sake of argument, let’s just assume all investors understand that change is constant.

Doesn’t matter.

Sometimes we all need reminders about what we actually own with an index (such as the S&P 500), and how the sectors we invest in expose us to risk when they fluctuate.

Think of this:

At the end of 1992, the S&P 500 had just over 5% exposure in technology companies. After the technology bubble of 2000, in only eight years, this percentage had grown to more than 33% of the index. (It dropped to just 12.6% by 2002.)

But today? At 26%, information technology is at its highest exposure since the technology bubble of the late 1990s. See Exhibit 1.

Exhibit 1 – Information Technology as a % of S&P 500 Weighting

Exit_1_B

For another example, as of 10/31/90, financial services companies made up just 6.5% of the S&P 500. By the end of 2006, financial services companies represented more than 22% of the S&P 500 index. In the depths of the financial crisis, this number dropped below 10%. In just a little over two years, the exposure in this sector was cut in half.

Today, financial services represents roughly 14% of the index. See Exhibit 2.

Exhibit 2 – Financial Services as a % of S&P 500 Weighting

Exit_2_B

At the end of September 1990, energy companies represented approximately 15% of the S&P 500. This dropped to as low as 5% by 1993, before climbing to a high as 16% on 6/30/08 (just before the financial crisis hit). Thanks to disruptive (there’s that word again) technology, such as horizontal drilling and fracking, we now have a much higher supply of oil and gas, and that means lower prices and lower profits.

The result is that energy now represents just 6% of the index. See Exhibit 3.

Exhibit 3 – Energy as a % of S&P 500 Weighting

Exibit_3_B

And, just for good measure, here’s one more example. At the end of September, 1994, materials (mining, metals, chemicals) represented over 8% of the index. In just 6 years, the exposure from materials companies went from 8% to under 2%: a 75%+ decline. Materials stocks got as high as 3.8% in 2008 before coming back down to their current level of 2.6%. See Exhibit 4.

Exhibit 4 – Materials as a % of S&P 500 Weighting

Exibit_4_B

When we look at the most “defensive” industries (these are sectors that will generally lower equity risk as they are typically less sensitive to the general market) – including consumer staples, utilities, telecom services, and the pharmaceutical portion of healthcare (we’re only referring to Pharma here as biotechnology and equipment stocks are not generally as defensive) – our findings are more troubling. The trend appears to be in a secular decline. At one time (at the end of 1991), this group of sectors made up roughly 40% of the S&P 500. Currently? The exposure of these sectors is a a mere 15.5%! See Exhibit 5.

Exhibit 5 – Consumer Staples, Utilities, Telecom Services, and Pharma as a % of S&P 500 Weighting

Exibit_5_B

Summary

The point is to always know and understand what you own (and why), and to be careful not to have too much exposure in the highest performing stocks (in addition to owning the broad equity indices). A 5% weighting in Apple combined with a 50% position in the S&P 500 is in reality a 7% position in Apple since the S&P 500 holds a 4% position in Apple.

For someone with a high tolerance for risk, and a very long time horizon, the above may be appropriate. For many investors, however, having diversified fixed income with just the right amount of duration is very important: especially for portfolios that have more equity exposure.

Equity indices currently don’t have as much in the way of defensive stabilizers (as in the past), so it makes sense that even the most aggressive investors might own some fixed income. Remember the saying of Warren Buffet? “Be fearful when others are greedy and greedy when others are fearful.” If bonds perform poorly and if everyone seems to be avoiding them, that very likely could be the optimal time to add some fixed income to a portfolio. The need to have a managed, diversified, and regularly rebalanced portfolio (with a risk-mapped asset allocation) may be greater today than at any point in recent history.

 


Source: The charts and data referenced here come from Bloomberg.
The S&P 500 Index is a broad based unmanaged index that consists of the common stocks of 500 large capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. You cannot directly invest in an index.
The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). You cannot directly invest in an index.
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May 21, 2018