Active investment management is often compared to a market index like the S&P 500. But that index, as with other market indexes, value weights stocks so is dominated by big firms. In July 2024, three stocks2MMicrosoft, Apple, and Nvidia2Mmade up 21% of the index while the largest five stocks made up 27% and the biggest ten 30%. By November, two firms, Tesla and NVIDIA, accounted for a third of the S&P 500 market value and a quarter of its profits (press reports). For the whole of 2024, the “Magnificent Seven” were up 67%, fueling much of the 25% gain for the S&P 500. The rest of the stocks in the index were up 17%.
NVIDIA alone accounted for almost 1/3 of the 15% return for the S&P 500 in the first half of 2024 and 55% of the return was due to five stocks (Wall Street Journal report, July 6, 2024). In the first half of 2024, the equally weighted S&P 500 was up only 4%. From 2022-2024 as these tech stocks soared, active managers’ returns were poor by comparison (except, of course, for active tech funds). Tech returns effectively became the benchmark, but one questions this benchmark for value investing, particularly with tech returns at the time generated by speculation about the future with AI. Of course, if the returns to tech at the time were returns to value, value investors could be criticized for not seeing that potential value. In the past, large banks (susceptible to considerable risk, as in 2008) and energy companies dominated market indexes.
A YouTube video discusses the issues of using the S&P portfolio as a benchmark and the traps in passive investing based on the index:
At the end of 2024, the forward P/E for the S&P 500 stood at 23.6 but the median P/E was only 17. That is a cue for investors: Don’t trade passively on the index but look for firms within the index that might be a better value proposition.