Authors: Stefan Yu and Daniel Schmitt, PhD
Time and time again market commentators write of narrowing equity markets as in recent history a small number of stocks contribute more than 100% to the index performance (“Equities: And then there were nine” – Jan 2016, “5 companies are carrying the S&P500” – May 2017, “These 10 Stocks Account for All of the S&P 500’s First-Half Gains” – July 2018).
The natural question to ask is how unusual is this phenomenon? We investigated the top 10 contributors to the MSCI USA index over the last 6 months over a 20-year period:
- The top 10 typically contribute around 40% to the index overall
- If index returns are small, % contribution can reach very large but meaningless sizes (pale bars in chart below).
- A large cluster of contributions greater than 100% with sizable index returns occurs during the TMT bubble between Oct 1999 and Jul 2000.
- May and June 2018 could be a hint of exuberance in the FAANG/MANA stocks but is still nowhere close to 1999 levels.
A persistent buzzword in the financial markets has been “narrowing” or a high level of index performance contribution from only a few index constituents. In that vein a recent Bloomberg article: “These 10 Stocks Account for All of the S&P 500’s First-Half Gains” By Luke Kawa July 2, 2018 discussed ten stocks that accounted for more than 120% of S&P500 (SPX) gains in the first half of 2018. In other words, while the SPX gained a net 79 index points (2.6%), a handful stocks gained more than 80 index points for SPX themselves (3%). It is no coincidence that nine of the ten stocks were among what we call the “BIG 10” – stocks that are the largest contributors to the overall index performance (aka Biggest Index Growers)[i].
In further analysis we applied a rolling six-month window inspired by the Bloomberg article to analyze monthly returns in the MSCI USA Price Index from 31.07.1997 to 31.07.2018 according the following formula[ii]:
Out of 250 periods (more than 20 years) there were 40 (=16%) instances in which the BIG 10 contributed more than 100% to index performance. A 12- month period around the 2000 bubble accounts for 10 instances occurring alone; excluding that year such a BIG 10 takeover becomes a once-or-twice a year occurrence (average 1.5 occurrences per 12 months)[iii]. In 1% of the cases (3 months out of 250 months) the 10 best performing stocks had impact of more than 500%+ on the index performance
We ran similar calculations for a 1-year timeframe and listed the Top 10 and Bottom 10 stocks each year. Over a year, the BIG 10 generally should not outpace the index (happened 2 out of 21 years). Maybe unsurprisingly the Top 10 stocks always have positive returns and the Bottom 10 always have negative returns, regardless of index performance. This highlights the importance of smart, active stock selection.
SIMAG has developed proprietary analytics models to anticipate directional price movements days or weeks in advance. By picking up complex LPPLS signatures our algorithms help our active managers pick BIG 10 stocks. For more information, visit www.simag.com
[i] If the index growth was positive, the top positive contributors to index growth were the BIG 10. If the index growth was negative, the top negative contributors to index growth were the BIG 10.
[ii] Price return and index return were calculated by subtracting the price at time t-6 from the price at time t, then dividing by the original price. The index weight of stock was based on market capitalization of the stocks and calculated by taking the weight at t, then adjusting the weight by the outperformance of the stock vs the index over the same period of time. We handled several exceptions in our analysis. Firstly, situations existed where index securities at tn did not exist in the index at t0. For these securities we looped through index (t1, t2, …, tn-1) to identify the date closest to n for which there was price data to calculate returns. Secondly, for instances where index return was negative (e.g. in a bear market), BIG 10 selected the worst performing stocks since they presumably dragged the index into negative performance.
[iii] BIG 10 impact is greatest when index growth is in the 0.1% range and individual stocks with non-negligible index-weights are performance outliers, leading to instances of 500% or greater contribution. In our recent bull-market between 2012 to present the BIG 10 consistently contribute around 2.5% to index increase – thus, with the index performing well impact of the BIG 10 has been moderate. This trend has reversed in the last two months as the index growth has slowed but the BIG 10 continue to grow, leading to the 120%+ contributions.