Zacks Investment Management

Many investors have likely seen stories or headlines about massive U.S. companies making up a disproportionately large share of the U.S. stock market. For instance, maybe you’ve seen this statistic, or one like it, before: as of December 31, 2021, the 10 largest stocks in the S&P 500 accounted for 30% of the index’s total value. In other words, just 2% of large-cap U.S. companies account for 30% of the benchmark large-cap index.¹

The concern that follows is also quite common – is the stock market too concentrated, with the index’s performance ultimately being decided by just a handful of companies?

Let’s consult the data. Over the past five years, the influence of the biggest companies has been apparent: the annualized performance of the S&P 500 (which is market cap-weighted, meaning the biggest stocks have more influence) was +18.47%. But if you weigh all 500 companies equally instead of by market cap, the annualized performance drops to +15.73%. On an annualized basis, the roughly 3% spread is significant. __________________________________________________________________________

Prepare Your Investments for Inflation, Volatility, and Other Uncertainties

One normal, but an uneasy factor to investing is sudden market changes. As investors experience changes and volatility, remember that feeling uncertain is common.

However, instead of panicking, we recommend focusing on factors that can impact your future investments! To guide you, we are offering all readers a look into our just-released January 2022 Stock Market Outlook report. This report will provide you with our forecasts along with additional factors to consider:

• Zacks rank S&P 500 sector picks
• Zacks view on equity markets
• What produces optimism in 2022?
• Zacks forecasts for the remainder of the year and the New Year
• Zacks ranks industry tables
• Sell-side and buy-side consensus
• And much more

If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! 

IT’S FREE. Download the Just-Released January 2022 Stock Market Outlook³

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However, if you zoom out further and compare the 20- and 30-year annualized returns of a cap-weighted versus an equal-weighted S&P 500, here’s what we find:

• 20-year annualized S&P 500 returns:
  • Market-cap-weighted: +9.51%
  • Equal weighted: +10.86%
• 30-year annualized S&P 500 returns:
  • Market cap weighted: +10.64%
  • Equal weighted: +11.92%²

Big companies having a big influence over the index is a relatively new phenomenon. Five of the biggest S&P 500 companies – Apple Inc., Microsoft Corp., Nvidia Corp., Alphabet Inc. (Google), and Tesla Inc. – accounted for roughly one-third of the S&P 500’s +28.7% return last year. This trend is significant short-term, but long-term, the data suggests capital will eventually rotate from high valuation (growth) to low valuation (value) names.

In 2022, there is a key factor to consider, which is that the Federal Reserve now appears likely to start increasing interest rates in the first quarter of this year and to begin trimming its ~$9 trillion balance sheet perhaps by summer. Higher interest rates and generally tighter monetary policy could create some headwinds for high valuation stocks, including some of those that reside at the top of the S&P 500 by market cap. Since many high valuation names arguably trade at high multiples because the discount rate for future earnings is so low, a higher discount rate makes future earnings less valuable today.

The argument I’m making here is not that it’s time to turn bearish and/or to expect below-average returns. My argument is that investors need to focus on every company in their portfolio, scrutinizing each stock to ensure the company is generating strong cash flows, maintaining solid gross profit margins (particularly in an inflationary environment), and delivering better-than-expected earnings consistently – all while trading at historically reasonable multiples.

This task will be tough in 2022, with earnings growth rates coming back to Earth as seen in the chart below.

In the past 10 years or so, capital has rotated quite a bit away from the value and small-cap stocks and towards growth and large-caps, generally speaking. Much of the growth surge happened because of technology’s continued rise, which accelerated greatly during the pandemic. Each of the five stocks I mentioned at the start of this column is riding that wave.

I think the question from here becomes whether capital – particularly in a rising interest rate environment – starts to rotate into other areas of the market that are now trading at a discount. The S&P 600 (an index of small-cap stocks), for example, currently trades at about 15x forward earnings, which makes small-cap stocks about 30% cheaper than their large-cap counterparts. Mid- and large-cap value stocks also look increasingly attractive on a relative basis.⁵

2022 may be set up as a year where some of the market’s concentration in high valuation stocks and a limited set of names gives way to capital rotation into undervalued companies that still generate strong earnings and cash flow. For investors, I think that means paying much closer attention to what you own and making a stock selection the top priority in the new year.

Bottom Line for Investors

For all the earnings and growth volatility generated by the pandemic over the last two years, the U.S. stock market has charged ahead. In 2021, equity investors who stayed the course likely experienced above-average returns with below-average volatility – certainly not what you might expect in a year as bizarre as that one.

I think 2022 will be more challenging – not because the stock market is poised to do poorly or because the risk of recession is high, but largely because earnings growth faces tough comparisons and the Federal Reserve will be tightening monetary policy throughout the year. For investors, I think this setup means making stock selection a priority. The first step: check your portfolio high multiple growth companies, which may feel stiff headwinds in a rising rate environment.

I also recommend staying focused on what matters – protecting your long-term investments. Even when the market experiences highs and lows, there are ways to do this. I am offering all readers our Just-Released January 2022 Stock Market Outlook Report.

You’ll discover Zacks’ view on:

• Zacks rank S&P 500 sector picks
• Zacks view on equity markets
• What produces optimism in 2022?
• Zacks forecasts for the remainder of the year and the New Year
• Zacks ranks industry tables
• Sell-side and buy-side consensus
• And much more

If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!

Disclosure