Out of curiosity, we conducted a really simple statistical test: We compared the correlation between the magnitude of government outlays as a percentage of the economy and the relative performance of these top dogs. We found a statistically significant negative correlation —suggesting that larger government outlays is bad news for top dogs (see Figure 1). Looking at government outlays and relative performance in concurrent one-year spans, the correlation is –31% based on 58 sample years. Where the change in government outlays is correlated with the following year’s average relative performance of the top dogs, the correlation is –27%. Combining the two results, the average top dog performance correlation with the two-year growth in government outlays is –38%.
Summary
From these results, one might conclude that an investor could do rather well by investing in the Russell 1000, minus its 12 sector leaders. Better still, perhaps we should exclude all of the companies that have been sector leaders any time in the past decade because the performance drag for the top dogs tends to persist for a decade or more. These stocks typically comprise about one-fourth of the Russell 1000! If these stocks suffer a 300–400 bps shortfall in most years, one could outperform the index by nearly 100 bps per annum merely by leaving the top dogs out, cancelling the corrosive influence of competitors, populists, and pundits.
Endnotes
1. A shorter version of this paper was published in the U.S. edition of FT.com on June 6, 2010. http://www.ft.com/cms/s/0/a1783e04-7002-11df-8698-00144feabdc0.html
2. There’s a wonderful film, “Phar Lap,” based on a true story about an Australian horse that beat all comers. Brought to the United States to compete, the horse continued to win. The horse was saddled with more and more weight, until its heart gave out. It finally lost.
3. Of course, there are other factors why some big firm’s don’t remain top dogs year after year, such as misguided diversification of business lines into non-core areas, deterioration of their culture, or emergence of new game-changing technologies. But that doesn’t change the fact that populist tendencies seek to bloody the biggest players.
4. I’m indebted to Vitali Kalesnik and Lillian Wu for the yeoman’s task of assembling and analyzing these data.
5. The unsuccessful periods are defined as those in which two or less top dogs beat their sect
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