Currently, the market value concentration in the S&P 500 stock index is near a record high.
The top five largest components of this index account for 20.4 percent of the total market value.
The exclusive group is made up of: Apple, Inc. (NASDAQ:AAPL) 5.1 percent; Microsoft Corp. (MSFT) 5.0 percent; Amazon.com, Inc. (AMZN) 4.4 percent; Google parent Alphabet, Inc. (GOOGL) 3.5 percent; and Facebook, Inc. (FB) 2.3 percent.
Five years ago, the makeup of the index was quite different. In fact, out of the top five companies, only three were high tech.
These three were Apple at 3.0 percent, Google at 2.3 percent, and Microsoft at 1.9 percent.
The other two in the list were Exxon Mobil (NYSE:XOM) and Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B).
Quite a difference.
And, just looking at the top five in each of the years, does not indicate at all about how technology stocks have come to dominate the stock market.
The Technology Advantage
The world is changing. I have written a great deal on what I refer to about the "new" Modern Corporation.
This is the future.
The major characteristics we focus on in the "new" Modern Corporation is the fact that the foundation of these companies is intellectual capital and not physical capital.
Oh, I know that these companies have a lot of physical capital, but when one examines the economics of these companies one observes that their marginal cost of expanding is zero or near zero. These companies can expand with very little additional cost.
This is because of the network effects associated with the building of linked communities.
These companies generate lots and lots of cash and have relied upon very little debt to expand their operations. They generally produce a return on shareholder's equity in the 15.0 percent to 25 percent range.
This is totally different from the "legacy" model where companies, at some time in their expansion, face rising marginal costs putting limits on their growth that are not faced by the "new" Modern Corporations. And, they do not generate cash at the same pace as the newer brands.
These 'legacy' companies also have tended to use more debt as they use financial leverage to boost their return on shareholder's equity to the 10 to 15 percent range if that is good.
The "new" Modern Corporation is where things are going as more and more "legacy" firms try and rebuild themselves, more in the form of their newer competitors.
And, the technology sector is growing, with "trends like artificial intelligence, 5G wireless technology, and big-data analysis" which will help to expand the impact of the technology stocks.
The Accelerating Future
And, the economic impact of the coronavirus pandemic, while it has hurt basic manufacturing, retail, and service areas, has actually contributed to the acceleration of many technological areas like cloud computing and digital payments.
In terms of the latter space, we hear more and more about how people are shifting the way they conduct their banking business. And, the impacts of these changes can be startling. Just consider how commercial banks are now considering the reduction in their bank branches.
For example:
"U.S. Bancorp, the country's biggest regional bank, said the shift will likely present opportunities to accelerate branch consolidation. Chief Executive Officer Andy Cecere expects to close more than the 10% to 15% targeted by the bank in 2019, he said during an industry conference last month. The bank counted about 3,000 branches at the time."
Six months ago, I knew nothing about a little enterprise called Zoom Video Communications, Inc. Currently, I am spending at least 12 to 15 hours every week facing a "zoom-like" get-together.
And, this doesn't even get into the changes I have already experienced in terms of health care treatment.
The point is, the future is arriving much faster than most everyone expected. And, this is impacting the investment future. And, it is boosting up the tech sector, the major component of the stock market.
The Possibilities Of A Stock Selloff
I have written recently about a possible stock sell-off in the near future. I added more support to this possibility in a follow-up article.
I still stand by what I presented in those two articles. We could get a stock selloff sometime this year. But we must try and understand what is going on in the whole stock market because the trends mentioned earlier in this article are going to impact what happens and it is going to impact magnitudes. And, investors need to modify their understanding of the markets to take these factors into account.
Amrith Ramkumar addresses these changes in his latest article in the Wall Street Journal.
Individual investors are pouring money into popular technology stocks, contributing to a booming rally that is leading major indexes higher…"
The faith investors have in fast-growing tech firms and historic measures by the world's central banks and governments helps explain how stocks have shaken off the worst US economic contraction and civil unrest in decades. Many internet stocks favored by individuals are also popular for hedge funds and institutional investors seeking asset with attractive growth prospects."
Maybe, more than ever, investors need to dis-aggregate their vision of the stock market and focus less upon aggregate indexes, like the S&P 500, and pay more attention to individual sectors. Focusing on the aggregate figures may hide a lot of what is actually going on in the economy and, consequently, distort their decision-making. What is taking place is a destruction of the "old" world, or at least a modification of it, and a bringing on of the "new".
And, all this is happening, right before our eyes. How bad can it get?