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Signs Of A Top-Heavy Stock Market


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The S&P 500’s “Weighted” version is trouncing its equal-weighted version.  That’s a concern.

It is not difficult to see major risks in today’s stock market.  But that does not mean that there is imminent danger.  All it means is that we must account for the risk factors and the reward potential that exist throughout the market.  Then, respond according to our objectives as investors.  Here are a couple of quick charts to show you what I mean.

YCharts.com

The chart above shows 2 of the many versions of the “S&P 500.”  The blue line shows the most commonly-used version, the one in which each of the roughly 500 stocks is weighted in the index according to its “market capitalization.”  In other words, the amount of stock (outstanding shares that exist, multiplied by the price of the stock) that exists in the market at a point in time.  In this case, the larger the company (in terms of its capitalization), the larger its weighting and influence on the S&P 500 Index.

The other important aspect of this “cap-weighted” method of viewing the S&P 500 is that the better a stock performs relative to the rest of the index (in weighted terms), the greater its weight in the index as compared to what it was in the past.  To cut to the chase on this, if stock XYZ sees its price zoom higher over the course of several months or years, its weighting can climb up the ladder within the S&P 500.  So, a stock that was a puny portion of the index some time ago could now be a huge influencer on the daily movement of the S&P 500 Index.  The other way to look at it is that the S&P 500 is largely driven by yesterday’s winners.  That can continue sometimes for years, but when it reverses, look out.  It can unwind years of gains, if not an entire retirement plan.

The chart above shows that the S&P 500’s market cap-weighted version has outperformed the “Equal-Weighted” version (in which each of the 500 stocks is given the same weighting, regardless of market cap).  This outperformance of cap-weighted over equal-weighted (on a 3-year rolling basis) has occurred over the majority of the past 10 years, the period shown in the chart.  You can also see that the gap between the 2 versions is about as wide as it has been in the past 10 years, with cap-weighted outperforming equal-weighted by about 2% annualized (10.89% to 8.96%).

YCharts.com

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Adobe Stock

The S&P 500’s “Weighted” version is trouncing its equal-weighted version.  That’s a concern.

It is not difficult to see major risks in today’s stock market.  But that does not mean that there is imminent danger.  All it means is that we must account for the risk factors and the reward potential that exist throughout the market.  Then, respond according to our objectives as investors.  Here are a couple of quick charts to show you what I mean.

YCharts.com

The chart above shows 2 of the many versions of the “S&P 500.”  The blue line shows the most commonly-used version, the one in which each of the roughly 500 stocks is weighted in the index according to its “market capitalization.”  In other words, the amount of stock (outstanding shares that exist, multiplied by the price of the stock) that exists in the market at a point in time.  In this case, the larger the company (in terms of its capitalization), the larger its weighting and influence on the S&P 500 Index.

The other important aspect of this “cap-weighted” method of viewing the S&P 500 is that the better a stock performs relative to the rest of the index (in weighted terms), the greater its weight in the index as compared to what it was in the past.  To cut to the chase on this, if stock XYZ sees its price zoom higher over the course of several months or years, its weighting can climb up the ladder within the S&P 500.  So, a stock that was a puny portion of the index some time ago could now be a huge influencer on the daily movement of the S&P 500 Index.  The other way to look at it is that the S&P 500 is largely driven by yesterday’s winners.  That can continue sometimes for years, but when it reverses, look out.  It can unwind years of gains, if not an entire retirement plan.

The chart above shows that the S&P 500’s market cap-weighted version has outperformed the “Equal-Weighted” version (in which each of the 500 stocks is given the same weighting, regardless of market cap).  This outperformance of cap-weighted over equal-weighted (on a 3-year rolling basis) has occurred over the majority of the past 10 years, the period shown in the chart.  You can also see that the gap between the 2 versions is about as wide as it has been in the past 10 years, with cap-weighted outperforming equal-weighted by about 2% annualized (10.89% to 8.96%).

YCharts.com

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