By Mark Hulbert, MarketWatch
America's 'winner take all' economy is alive and well
Since the U.S. stock market peaked on Feb. 19, the five stocks with the largest market caps have nonetheless beaten the market.
I'm referring to Apple (AAPL) , Microsoft (MSFT) , Amazon.com (AMZN) , Alphabet (GOOGL) and Facebook (FB) . Since the market's high, these stocks are down an average of 22.9%, according to Factset, versus a 26.6% loss for the S&P 500 and a 27.5% loss for the Dow Jones Industrial Average . (Returns through Mar. 25.)
These largest stocks' relative strength has surprised some observers, who had expected that these stocks, which had dominated the bull market on the way up, would be among the biggest losers on the way down.
But a new study suggests that, far from indicating the stock market has become top-heavy and overvalued, the dominance of the largest stocks is a symptom of a much more profound and longer-term shift: The stock market is becoming split between a few large firms that are wildly profitable and everything else.
Authored by Hendrik Bessembinder, a finance professor at Arizona State University, the study is entitled "Wealth Creation in the U.S. Public Markets 1926 to 2019 ()." In it, he updates his previous research that had analyzed data through 2016.
Consider, for example, how definitively these same five mega-cap stocks dominated the bull market that just came to an end. Bessembinder reports that, over the three calendar years through 2019, these five stocks accounted for an incredible 22.1% of the total wealth created by the entire stock market.
This concentration of wealth creation creates big challenges for those trying to create diversified stock portfolios. Consider that in Bessembinder's database there were 4,896 publicly traded stocks in the three-year period ending December 2019. Notice that you could have constructed an index fund out of all but five of those stocks -- 4,891 in all -- and still trailed the market by 22.1% if those five missing stocks were Apple, Microsoft, Amazon, Alphabet and Facebook.
That's amazing, because you'd otherwise have been confident that a portfolio containing more than 4,000 issues, constituting 99.9% of all publicly-traded stocks, was more than adequately diversified.
Here's another way in which Bessembinder makes the same point: How many companies are needed to account for 50% of the total wealth creation over the trailing three years? The answer for the three years ending this past December is just 48 out of the total of 4,896 -- or 0.98%. This is one of the lowest percentages of any three-year periods since the 1920s, as you can see from the chart below.
To put that in perspective, consider inequality of wealth in the U.S. -- a topic that has received enormous attention in the Democratic primaries. According to the Brookings Institution (/), the top 1% of Americans own 29% of the total wealth in the U.S. Skewed as that is, wealth inequality is nearly double that in the stock market, where the top 1% account for 50% of total wealth creation.
What's happening in the stock market is yet more evidence that the U.S. is moving towards a "winner take all" economy. I'm referring to a prediction made in 2005 in the Journal of Economics & Management Strategy () by Thomas Noe of Oxford University and Geoffrey Parker of Dartmouth. The researchers predicted that, because of so-called "network" effects in an internet-based economy, industries will become increasingly dominated by their largest companies. In an interview, Bessembinder told me that his results clearly are consistent with Noe's and Parker's prediction.
The investment implication of this new research is that diversification is more important than ever. Unless you're confident that your portfolio owns each of the stocks that will be the top performers in coming years, you should seriously consider putting your money in a broad market index fund.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org (mailto:email@example.com)
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-Mark Hulbert; 415-439-6400; AskNewswires@dowjones.com
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March 26, 2020 16:00 ET (20:00 GMT)
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