Total Concentration: Mega Caps Reign

May 31, 2023

6 minute read

by Liz Ann Sonders, Chief Investment Strategist, Charles Schwab & Company Ltd.

The concentration of gains up the cap spectrum isn't itself a precursor to weakness; it's the lack of participation from the "average stock" that warrants some caution.

An ever-popular question these days is whether the October 12th, 2022, low for the S&P 500 was "the" low—and thus, if the bear market is over. The short answer is no one knows, and that may be the case for some time.

To add more color to the debate, the chart below shows the maximum percentage declines for all S&P 500 bear markets since the 1960s. If the bear market did indeed end back in October, it would have lasted for 195 trading days, which is about average when considering the entire sample size. If the bear market is still ongoing (meaning, the October low is to be broken through), this bear is getting longer in the tooth, now being more than a year old.

That length isn't unprecedented, however. Sticking with the possibility that the bear market isn't yet over puts it in the company of bears that started in 2007 and 1968 (and beyond that, 1973, 1980, and 2000). The worst-case scenario would be something akin to the bear that started in 2000, which was clearly the most frustrating drawdown (in terms of timing, not magnitude) in the collection below.

How low can you go

: Chart shows the S&P 500's peak-to-trough bear market declines going back to 1960.

Source: Charles Schwab, Bloomberg, as of 5/26/2023.

Data indexed to 0% at the start of each bear market. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

"The market" vs. the market

One of the discomforting (and widely advertised) aspects of the market's advance this year has been the concentration of gains up the cap spectrum. Leadership among the mega-cap names—and the sectors in which they are housed (Information Technology, Consumer Discretionary, and Communication Services)—has strengthened while the "average stock" hasn't moved much at all.

As shown below, there is quite a wide performance gap between the 50 largest names in the S&P 500, the overall S&P 500, and the Russell 2000. Looking at the two extremes, over the past 60 trading days, the 50 largest names are up by 11.7%, while the Russell 2000 is down by 6.7%. It's an important distinction to make, especially given the excitement over the so-called resilient nature of "the market" this year. If "the market" is a handful of mega-cap names, then performance looks great; if it's the rest of the crew, the story looks different.

Mega caps rolling higher

Over the past 60 trading days, the 50 largest names are up by 11.7%, while the Russell 2000 is down by 6.7%.

Source: Charles Schwab, Bloomberg, as of 5/26/2023.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

The underperformance down the cap spectrum is worrisome for a couple reasons. First, back in 2021, small caps and the "average stock" were under a lot more pressure than the headline indexes showed. A series of rolling corrections and bear markets under the surface ultimately preceded what turned out to be a full-blown bear in 2022. Second, with the economy now fully reopened, the absence of any strong performance from key cyclical segments of the market (i.e., small caps) would be worrisome.

Shown below, narrowing the scope further, the five largest names in the S&P 500 have decisively outperformed their peers (the other 495) this year (most notably in March and May). We're not of the thought that the mega-cap outperformance in and of itself is a precursor to imminent market doom, but at some point, the lack of participation from the rest of the market should be noted as a likely sign of coming deterioration.

Generals vs. soldiers

The five largest names in the S&P 500 have decisively outperformed their peers (the other 495) this year (most notably in March and May).

Source: Charles Schwab, Bloomberg, as of 5/26/2023.

"Top 5" represent five largest stocks in the index by market capitalization in any given month. "Other 495" represent the rest of the index not included in the top five. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

A weak start

As mentioned at the beginning of this report, if one were to assume we're still in a bear market, it's getting long in the tooth. Embracing the opposite assumption—that we're in a new bull market—means the October low is not to be revisited, given we'd be in a new bull cycle. If that's the case, this would be one of (if not the) most underwhelming starts to a new bull market in history.

One way of seeing that is via the performance of small caps (proxied by the Russell 2000). As shown in the table below, going back to the inception of the Russell 2000, small caps have always tended to do well when the market was this far beyond a major market low (decline of 20% or more), given they're closely tied to the economy. The current gain since October clearly stands out in a not-so-good way.

Small caps' weak start

Going back to the inception of the Russell 2000, the index has always performed well 156 trading days after a major market low. That isn't the case today.

Source: Charles Schwab, Bloomberg, Strategas Research Partners LLC, as of 5/26/2023.

156 days represents duration of current 10/12/2022 S&P 500 low date. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

The same goes for another key, cyclical part of the market—the banks. As shown in the table below, going back to the 1960s, banks have always tended to have strong performance gains after a major market low, regardless of whether they outperformed the S&P 500. Through Friday's close, the KBW Bank Index is down by 17.8%.

No bounce in the banks

Going back to the 1960s, banks have always tended to see gains after a major market low, regardless of whether they've outperformed the S&P 500. Through Friday's close, they're down by 17.8%.

Source: Charles Schwab, Bloomberg, Strategas Research Partners LLC, as of 5/26/2023.

Fama-French data used for bank returns prior to 2002. KBW Bank Index used for bank returns after 2002. 156 days represents duration of current 10/12/2022 S&P 500 low date. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Rounding out our table analysis and shown below, the market's breadth looks quite weak today in comparison to prior bull market beginnings. Breadth data is quite limited, so we can only look at the four major bear markets that preceded the one in 2022, but nonetheless, it's in much weaker territory this time around. Through Friday's close, the share of S&P 500 members trading above their 50- and 200-day moving averages was 36% and 44%, respectively. That compares to respective averages of 64% and 81% for the 156 days after the conclusions of the prior four bear markets.

(No) breadth of fresh air

Through Friday's close, the share of S&P 500 members trading above their 50- and 200-day moving averages was 36% and 44%, respectively.

Source: Charles Schwab, Bloomberg, as of 5/26/2023.

Finally, another sign of the market's weak breadth is that only 12% of S&P 500 stocks are outperforming the overall index on a 60-day trailing basis. As shown below, that's an all-time low going back to 1993 (and notably, lower than it was in March 2000 at the peak of the tech bubble). The seven largest stocks in the S&P 500 are all up over the last three months with an average gain of 29.3%, while the seven smallest stocks are all lower and down by an average of 33.3%.

No peak performance

Only 12% of S&P 500 members are outperforming the overall index on a 60-day rolling basis. That is the weakest share going back to 1993.

Source: Charles Schwab, Bloomberg, as of 5/26/2023.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

In sum

Market performance has become top-heavy again, with investors biased toward the largest technology and tech-related stocks. Only 36% of the S&P 500 stocks are trading above their 50-day moving averages, and only 44% are trading above their 200-day moving averages. As Michael Caine once said about a duck: calm on the surface but paddling like the dickens underneath.

The concentration into the mega caps kicked into high gear at the beginning of the current banking crisis in early March, with the added kicker of enthusiasm around artificial intelligence (AI). Our advice is to be wary of concentration risk in your own portfolios and use periodic rebalancing to keep individual positions and market segments from ballooning in relative size. Mean reversion is inevitable at some point, although trying to pinpoint the timing can be an exercise in futility.