As we mentioned in a prior post, the S&P 500 index has developed into the way most investors view and discuss the U.S. equity market, and the index has become very concentrated into a small number of stocks. The NASDAQ 100 reached a new high on June 5th, the NASDAQ Composite reached a new high on June 8th, and the S&P 500 had a new record high on August 12th. While these indices have reached new highs, many of the underlying stocks that make up these indices and “the market” have not.
When the NASDAQ 100 reached a new high, 48% of the underlying stocks were up from their February 19th level (prior index high) and 52% were below that level. Of the underlying stocks, 5.5% were up 20% or more and 5.5% were down 20% or more from their February high. By the end of August, only 35% of the underlying stocks were below their February level and 38% of the underlying stocks were up more than 20%, compared to only 11% that were down more than 20%. While the NASDAQ 100 is a very concentrated index (the top three stocks are 35% and the top five are 44% of the index), most of the underlying stocks have been participating in the rally and the return distribution is positively skewed.
The broader NASDAQ Composite has 2,700 underlying stocks and has a different looking distribution. When the NASDAQ Composite reached a new high, 66% of the underlying stocks were below their February 19th level and 31% were down more than 20%. This compares to 15% that were more than 20% above their February level. As of the end of August, 63% of the underlying stocks were still below their February level and 42% were more than 20% below that level. This compares to 22% that were more than 20% above their February level.
As of the end of August (a few weeks after the S&P 500 reached a new high), 60% of the underlying stocks were below their February 19th level and 32% were down more than 20%. This compares to 13% that were more than 20% above their February level. As of September 4th, 222 (44%) of the underlying stocks in the S&P 500 had a 0% or negative return over the trailing 12 months, and a similar amount had a flat or negative return over the trailing two year period.
This negatively skewed distribution is occurring at a time when the index is at record levels of concentration (based on the top 5 and 10) as the top five stocks represent 23% of the index, the top 10 stocks represent 30%, the top 20 stocks represent 39%, and the top 40 stocks represent 51% of the index.
While not all of the stocks in the index are up, volatility is a factor we track that is rising. Indexes that are designed to track the implied volatility in options markets for the S&P 500, NASDAQ Composite, and Russell 2000 all increased significantly last week. Mega-cap technology stocks experienced large increases in volatility as illustrated by the sizeable increase in Apple volatility. The current levels on these volatility indexes have historically correlated to low returns for equity indexes. How these volatility indexes respond in the next few weeks could be very telling for equity index returns. Since only a small subset of the largest names have been driving the recent gains, any reversal in their direction could create a major headwind for the overall index (unless a majority of the small stocks start to experience large gains).
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC