Why is the Market So High?

Last week, I wrote about the risk of investing in individual stocks and highlighted the chart below. As you see, the Nasdaq 100 currently sits near all-time highs, while many speculative stocks have entered and surpassed bear market territory (A decline of 20% or more). This week, I’ll elaborate on this idea, as well as give you some insight into a few other risks we keep our eye on when constructing portfolios.

As I mentioned, most of the names above do lean towards the “meme” stock world, and the Nasdaq 100 is constructed of the largest Technology and Health Care companies in the world.

However, this story of disconnection is popping up across the broader market as well. Below is a chart from research analyst Ben Carlson, which dissects the entire stock market.

Through December 3^rd, the stock market is up a little over 23% for the year. Though, if you dissect through the individual names, a third of the stocks are negative for the year and 20% are in bear market territory.

Which begs the question… How is the stock market still at or near all-time highs, when all these individual names are getting crushed? The simple answer… Market Cap Weighted Indexes

In market-cap-weighted indexes, the largest companies receive the largest weighting in the index. As you can see below, many of these large stocks have hit it out of the park in the past year and the stock market has benefited from it.

The top 10 names in the S&P 500 account for roughly 30% of the entire index. This is great news because nearly everyone one of them is in the chart above. However, this is something Ed and I are keeping a close watch on when we are constructing portfolios.

If these large-cap names, which make up most of the indexes decide to sell off, it could be potentially disastrous for large market cap indexes. Before you think, “that can’t happen” keep your history lessons in mind. Many of the high flyers from the past (GE, Xerox, AIG) went on to crater. All of these stocks were considered “too big to fail” and a “sure thing” by the financial press.

Now, this isn’t a hit piece on passive indexes or large market cap companies, however, it is a reminder that things to do change over time. Just look at the chart below which breaks down the top 10 holdings in the S&P 500 by decade dating back to the 1980s. Oil, GE, and AIG were all no-brainers in the 80s and 90s. Fast forward to today, the entire energy market makes up less than 3% of the S&P 500, GE is down roughly 80% from its all-time high in 2000, and AIG has lost 96% of its value from the peak.

The takeaway… In portfolio management knowing the “how” results have been gained and potential downside risks is critical. It’s one of those things we spend hours and hours reviewing, analyzing, and “what-if’ing”.

If you are constructing or handling your own portfolios, be aware of what you own and how much exposure you have in any individual names. Even when the names are within an index or mutual fund. Understand the composition of your portfolio and the attribution of performance in both up and down markets. Stick to your plan and don’t take unknown excessive risks.

Lastly, we are actively accepting (and encouraging) referrals from our clients. With the addition of another advisor, we now have the ability to accept and service new clients. If there is anyone you care about who might benefit from a second set of eyes, we would be happy to help.