The rise (and rise) of big tech in the US

Articles 7/10/2020

While the world remains unvaccinated against a pandemic that's now infected over 36 million including 7.5 million Americans, the US equity market (S&P 500) is up 4% for the 2020 year-to-date; a surprising outcome when you consider the events of the last nine months. Our local market (S&P/ASX 200) is down 11% for the year-to-date despite arguably achieving a better health outcome. Putting policymakers' response to the global health crisis aside for a moment, it's interesting to delve a little deeper to understand what is behind this discrepancy, who are the companies driving these outcomes and what does it mean for investors? 

Much of the discrepancy can be explained by the 'big 5' technology stocks (Facebook, Amazon, Apple, Microsoft and Google [Alphabet]). These dominant global technology and digital platform businesses have delivered a combined average return of 46% year-to-date. The remaining 495 companies in the S&P 500 delivered a far more subdued -2% return (refer to the chart below) for the year-to-date: a vast divergence in fortunes that suggests on aggregate, the rest of the broader US equity market has struggled in the face of the pandemic.

 

The US equity market today has never been more influenced by so few stocks. While these names may well continue to deliver strong returns, it's important we acknowledge the sizeable concentration inherent in the index: something many passive Australian equity investors know all too well where our equity market remains dominated by the banks and resources that continue to make up over 50% of the ASX 200.

The magnitude of the big 5's outperformance this year combined with their sheer size has led them to now comprise almost 23% of the S&P 500 after being 15% only twelve months ago. To put this into context, the top 5 stocks in the S&P 500 over the last 25 years have averaged only 13% of the index. The last time we saw a comparable level of concentration was back in 2000 during the peak of the dot-com bubble (refer below) where Cisco, Microsoft and Intel, combined with GE and ExxonMobil were 'the big 5' of the day.

 

It's quite extraordinary to have so few companies driving such a large portion of the broader market index. The big 5 today have a market capitalisation of about US$6.5 trillion, equivalent to the combined market capitalisation of the bottom 389 companies in the S&P 500. Those 389 include the likes of DuPont, General Motors, Hewlett-Packard, Kraft-Heinz, Micron (who manufacture semiconductors), Twitter and Yum Brands (owner of KFC, Pizza Hut and Taco Bell). While this list contains a number of 'old world' names, a number of household staples and next-generation businesses are also present.

The meteoric rise of big tech in the United States is perhaps best illustrated by Apple who now alone is 6.5% of the S&P 500, recently breaking IBM's 1985 record for the highest single company weighting in the index. Apple recently became a US$2 trillion market capitalisation company. What's incredible is that the 2nd trillion dollars came in just the last 2 years where the rise in its valuation multiple drove almost 90% of this growth (higher earnings per share delivered the remaining 10%).

Looking comparatively at our local market, the 5 commonly discussed ASX-listed tech stocks of Wisetech, Afterpay, Appen, Altium and Xero have delivered a similarly-impressive combined average return of 57% for 2020-to-date. However, unlike the big 5 in the US these names make up less than 3% of the ASX 200, resulting in a far smaller impact on our index.

While the big 5 US names have indeed delivered solid earnings growth, the market's willingness to pay more for these companies has been driven by the expectation of this continuing long into the future. In a world where we've seen an acceleration of structural trends such as the rising adoption of e-commerce, digital advertising and cloud computing, such expectations may be justified. However we must always consider valuation in assessing the appropriate price to pay for this prospective future growth.

While our international allocation in portfolios invest in some of the big 5, capturing a portion of their recent gains, we feel it prudent to take a more balanced approach. We believe there are countless other highly successful global businesses (including some listed outside the US) that we expect will deliver attractive earnings growth.  By partnering with a select number of high-quality active managers, we seek to construct a more balanced, truly diversified global equity portfolio for our clients.

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