Not Everyone Is A Winner

While in the midst of COVID-19, historical levels of unemployment, unprecedented levels of economic stimulus, and falling corporate profits, the Standard & Poor’s 500 Index (S&P 500) is in positive territory for 2020. The economic data would indicate we are in a recession, yet U.S. equity markets are not behaving as such. A recent article by writer Adam Grossman investigates what’s going on “under the hood” and identifies that the bulk of positive returns this year have come from five companies that make up 20 percent of the S&P 500 market cap. The five juggernauts of the S&P 500 (Alphabet, Amazon, Apple, Facebook, and Microsoft) have a year-to-date return of 35 percent, whereas the remainder of the index’s constituents have returned -5 percent over the same period. Approximately 300 of 500 index constituents are in the red for this year, showcasing that the bulk of the market returns are coming from just a handful of companies. While this may seem both absurd and unsustainable going forward, Grossman cites a study by finance professor Hendrik Bessembinder in which he finds that over a 90-year period, less than 4 percent of companies account for the entire index’s return. The major findings from Bessembinder’s paper highlight how the skewness of returns realized by individual companies impacts broad market indices, and how it is normal for a small group of companies to contribute disproportionately to index returns. The main takeaway from Bessembinder’s paper and the article from Grossman is that picking winners in the equity market is a tremendously challenging endeavour, and ensuring one’s portfolio is sufficiently diversified is the best way to gain exposure to the equity risk premium while reducing the risk of not having any exposure to the big winners of the index.