Gains That are Worth the Weight
Let’s talk about something that’s triggering for a lot of people: weight.
Don’t worry. I’m not here to make some outdated comment about women’s figures or parrot poor advice from some toxic fitness influencer.
Instead, we’re going to talk about the one weight you should care about … the index weighting.
Here, that number on the scale is far more important than you might think.
And knowing which indexes are overindulging on a select few names can ensure you outperform the markets each year. Plus, that little bit of knowledge can help you identify some areas in your own portfolio where you may need to slim down or bulk up in 2023.
3 Years from “Phat!” to “Crap …”
By and large, 2019, 2020 and 2021 were tremendous years for equities.
I know. Some are going to argue … “But what about the COVID Crash?”
Indeed, in 2020 the markets suffered their fastest 30% drop in history. The decline took place over a terrifying 22 days. And that led to plenty of investors vice binging. They needed comfort from the stress of their portfolios undergoing a dangerous crash diet.
But that nightmare was followed by the shortest, most cuddliest bear market ever. It was so cute. It only lasted a delightful 33 days (that’s only 3 days longer than a Whole30 program).
And then the markets didn’t stop going up from there.
In turn, the S&P 500 averaged a wolf-whistle-inciting 24% annual return from 2019 through 2021.
That’s 140% better than the historic 10% average annual return for the S&P!
To put it another way, $10,000 invested into the SPDR S&P 500 ETF Trust (SPY) on January 1, 2019, would’ve grown to $20,028.66 (including dividends) by December 31, 2021.
With returns like that, many people thought they were well on their way to the retirement of their dreams.
Then 2022 arrived on the scene like a garbage bag full of wet mango pulp slamming into concrete.
Inflation skyrocketed to 40-year highs. Home prices and mortgage rates soared past laughable straight to unaffordable. The pandemic shut down manufacturing plants around the world. And the supply chain snarl created chaos in everything from appliances and crude oil to lumber and used cars.
The Federal Reserve was forced to bulk up interest rates to try and bring this all back under control.
Force feeding rates a steady, high-protein diet of 75 basis point (bps) and 50 bps increases, they shot up twice as fast as they did during the Alan Greenspan 1988 to 1989 Fed rate hike cycle.
And we’re not done, at least not quite yet.
Most important of all, hefty interest rate hikes are too heavy for some sectors of the markets to carry.
And in 2022, struggling with all this extra weight, the Dow Jones Industrial Average finished the year down 8.7%.
The S&P 500 closed last year with a loss of 19.6%. And that $20,028.66 you had at the end of 2021 in your SPY investment had whittled away to $15,804.13.
Meanwhile, the Nasdaq tore a hammy in 2022, falling 33.4%.
At this point you’ll notice that not all indexes are equal. Far from it. If they were, their returns would be the same.
So, why such the vast difference in performance between the three U.S. indexes?
Thin Profits = Heavy Burden
Tech is both a gift and a curse.
The sector is fleet of foot during normal economic periods. Its products are often ethereal, “in the cloud,” and tech’s razor-thin profit margins and high debt loads aren’t an encumbrance most of the time.
But once interest rates start going up, they create too heavy of a load for the sector to shoulder. And shares of tech companies buckle under the weight.
For indexes, being overweight or underweight tech can make all the difference.
Now, not all indexes are equal. Nor are an index’s components equal weighted (that would simply make too much sense). On top of that, each of the indexes use different approaches to determine how much weight a single component should account for.
For example, the four heaviest weighted components on the Dow are UnitedHealth Group (UNH), Goldman Sachs (GS), Home Depot (HD) and McDonald’s (MCD).
The Dow is a price-weighted index. And when we see these names, we tend to think ‘traditional economy.” Insurance, financials, home improvement and fast food.
Well, the four heaviest weighted components of the S&P are Apple (AAPL), Microsoft (MSFT), Amazon (AMZN) and Alphabet (GOOGL).
Those are the largest of big tech names. And the S&P is a float-weighted index.
Finally, on the Nasdaq – a market cap-weighted index - the four largest heaviest components are Apple, Microsoft, Amazon and Nvidia (NVDA).
Right off the bat, it’s easy to see the S&P and Nasdaq are much more reliant on technology than the Dow for their health.
And remember, that’s just the top four.
Technology accounts for roughly 45% of the Nasdaq’s total weighting. On the S&P 500, it’s more than 37%.
In a rising rate environment, like we had in 2022, technology suffers the most. These thin margins are a heavy burden investors don’t want.
For example, UnitedHealth’s revenue was $324 billion. And the insurance giant earned $22.19 per share Amazon, reported total revenue of $513.9 billion in 2022 with a loss of $0.27 per share. The e-commerce giants sales were more than half a trillion dollars, but it failed to turn a profit.
UnitedHealth shares slipped a mere 2.8% last year. Amazon’s fell 50%.
This is why you avoid tech like unwanted carbs is a rising rate environment. And that also means reducing your exposure to tech-heavy indexes during these periods.
But here’s where this index weighting is our opportunity …
Cut Out Oil for a Healthier Portfolio
There’s a new diet plan in store for 2023.
And it’s one that directly impacts the biggest losers and winners from 2022.
Thanks to the war in Ukraine, energy is coming off a banner year. The top 10 performers on the S&P in 2022 were oil & gas stocks.
Many of the worst performers were tech.
Well, the Fed has already scaled back its rate increases in 2023 from 75 bps to 25 bps. And we’re all waiting for rate hikes to stop altogether.
It’s only a matter of time.
This is great news for those slimmed down tech companies. These have already slashed their workforces by more than 100,000 year-to-date. They’re nearing tip-top shape to run their next marathon.
And those indexes that rely on these tech legs to drive them higher - the Nasdaq and the S&P - will really outperform this year.
It’s already happening.
The Dow is negative for 2023.
Meanwhile, the S&P 500 is up roughly 4%. And the Nasdaq has doubled that pace, up nearly 10%.
The only weight that matters this year is tech. To thrive, not merely survive, cut out those oil stocks. Instead load up on healthier options for your financial future: technology shares and indexes heavily weighted to tech. Your portfolio will thank you.
Relish today. Ketchup tomorrow,
Matthew
© 2023 Matthew Carr
All rights reserved.
This market commentary is opinion and for entertainment purposes only. The views and insights shared by the author are based on his many years of experience covering the markets. But nothing in this email should be considered personalized investment advice. Investments should be made after consulting your financial advisor and after reviewing the financial statements of the company or companies in question.