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Portfolio Perspectives

Explore the intersection between timely topics and potential effects to your investments in Portfolio Perspectives reports.

June 15, 2021

David Furst, CFA®, Advice Strategy

Taylor McLeod, Analyst

S&P 500 – The Economy’s Mirror

Investment Implementation

2020 was a volatile year for the markets – enduring a rollercoaster ride through the ups and downs. It began with an expansion of the longest bull market in history until it was disrupted by the COVID-19 global pandemic, which sent the market in a deep decline. During the trough of the market sell-off, trading volume jumped. After losing around one-third of its value in a month, the market rebounded as this became the shortest bear market on record. 2020 concluded with a robust rally of positive market performance, continuing into 2021. Over the decades, the changing nature of the American economy has had a dramatic impact on the nation’s companies and industries in which they compete. One way market participants gauge the health of the economy is through looking into the economy’s mirror – the Standard & Poor’s 500 Index (S&P 500). Investors often follow index funds, which track a specified basket of underlying investments that seek to replicate the movement and momentum of the market. The S&P 500 is one of the most widely watched benchmarks and can be used as a bellwether for reflecting not only stock market performance but it speaks volumes towards consumer preferences and investor sentiment.

Price and Volume of the S&P 500 through May 2021Price and Volume of the S&P 500 through May 2021Source: Wells Fargo Advisors. Data provided by FactSet as of May-28-2021 for S&P500 Index price and trading volume. Trading volume represents the total volume of all constituents that are included in the S&P 500 Index. Index return information is provided for illustrative purposes only. Index returns do not represent investment returns or the results of actual trading nor are they forecasts of expected gains or losses a fund might experience. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment. Past performance does not guarantee future results.

The S&P 500 is a market capitalization weighted index of the 500 largest publicly-traded companies in the country, allowing for a diverse measure of the major sectors within the economy. Over the years, the composition among its 11 sectors has continued to shift as the underlying constituent’s market capitalizations increase and decrease. Whereas materials, manufacturing and industrials represented a larger presence in prior decades, the most drastic moves among the sectors in recent years has been the growth within Information Technology and reduction within Energy. The Information Technology sector did not even exist when the benchmark was created in 1957, and now it displays the largest allocation among the S&P 500. Amid the 2020 global pandemic, the technology sector sustained its dominance, becoming a crucial part of many peoples’ everyday life. As the S&P 500 tracks the value of the US economy, it continues to reflect new trends and consumer sentiment, such as an acceleration towards digitization and the use of artificial intelligence, which leaves an impact on the companies and industries comprised within the S&P 500 Index.

S&P 500 Index Sector Composition over TimeS&P 500 Index Sector Composition over TimeSource: Wells Fargo Advisors. Data provided by FactSet as of Dec-31-2020 for S&P500 Index.

Concentration

The S&P 500 Index is a meaningful measure of the underlying movement of the U.S. stock market as the largest companies compete in a robust economy. The S&P 500 is a market capitalization-weighted index as the constituents with larger market capitalizations are given a higher percentage allocation. Therefore, not all 500 positions are equally weighted. Often times, companies with a greater allocation can express a larger influence on the overall S&P 500 performance, correlating closer to the broader U.S. stock market. This unequal weighted distribution impacts the diversification among investors’ portfolios as some of the largest companies in America, which represent many products and services used on a daily basis, hold a greater concentration within individual portfolios as well as the S&P 500 Index. For example, a client might think they are getting an equal weight exposure to all 500 companies when they buy an index fund of the S&P 500, when in reality, they are receiving ~ 25% FAANMG stocks (Facebook, Apple, Amazon, Netflix, Microsoft, Google).

Market Capitalization

As the market has moved up and down over the years, the concentrations of the top weighted positions by market capitalization within the S&P 500 Index have shifted. The market capitalization method is calculated by dividing a company’s market capitalization by the total of all market capitalizations to determine the individual representation within the index. A company’s market capitalization depicts the total market value of their outstanding shares, which is determined by 3 June 2021 | Portfolio Perspectives multiplying the current stock price and the number of shares outstanding. Therefore, market capitalizations can shift due to changes in the stock price or when a company issues or repurchases shares.

In 1990, the top five companies represented 12.3% of the S&P 500 Index, jumping to nearly 22% for the year of 2020. The chart below displays the past thirty year’s top-five weighted companies by market capitalization within the S&P 500 Index.

% of Top 5 Weighted Companies by Market Capitalization within the S&P 500% of Top 5 Weighted Companies by Market Capitalization within the S&P 500Source: Wells Fargo Advisors. Data provided by FactSet as of Dec-31-2020 for S&P500 Index. Individual concentrations rounded to nearest decimal point. Past performance does not guarantee future results. An index is not managed and not available for direct investment.

Marking a pivotal peak in the year of 2020, the top five weighted positions paced record high concentration levels, doubling from 10.9% to 21.7% in the past ten years. As the market continues to digest economic data and industry trends, the composition and concentration levels within the S&P 500 Index evolve with the ebb and flow of organic and inorganic growth (mergers and acquisitions). The competitive strategies of horizontal and vertical integration impacts the growth and consolidation among the many competitors within the market.

The bar graph below displays the top-five market capitalized companies and their respective weightings within the S&P 500 Index for the years 1990, 2000, 2010, and 2020.

As market trends change throughout the years and new technology advancements are made, companies are impacted and their allocations fluctuate as a result. Looking closer at the data from these four years on the bar graph below, two companies, Exxon Mobil and General Electric, made the leaderboard of the top five concentrated positions of the S&P 500 for three of the four highlighted years: 1990, 2000, and 2010. For the year of 2020, the Information Technology sector demonstrated a strong dominance with Apple, Microsoft, Alphabet, and Facebook representing four of the top positions by market capitalization. Amazon took the third spot on the 2020 leaderboard, representing the Consumer Discretionary sector. Apple paced a large allocation gain within the S&P 500 Index from 2010 to 2020, increasing its weighting from ~2.6% to ~6.7%. By capturing more market share, Apple, Microsoft, Amazon, Alphabet, and Facebook exemplified the themes of growth and concentration as their combined market capitalizations outpaced prior years. After a thirty year period, the importance of diversification remains prevalent as the S&P 500 Index reflects a wide variety of companies and industries among all sectors of the economy.

S&P 500 Index Top 5 Weighted Stocks for 1990, 2000, 2010, and 2020S&P 500 Index Top 5 Weighted Stocks for 1990, 2000, 2010, and 2020Source: Wells Fargo Advisors. Data provided by FactSet as of Dec-31-2020 for S&P500 Index. Individual concentrations rounded to nearest decimal point.

As it comes time to review your portfolio with your financial advisor, consider taking a deeper dive into the overall diversification of your portfolio. Incremental changes within market indices from year-to-year may go unnoticed, but over time, they can result in seismic shifts within the diversification of a portfolio.

Risk Disclosures

Different investments offer different levels of potential return and market risk. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors.

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