As Sam Sees It: An Equalizer for the Tech-Heavy Stock Market

Sam Stovall |

Sam Stovall Chief Equity Strategist for S&P Capital IQEach week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

EQ: In this week's Sector Watch report, you noted that the three largest Tech companies on the S&P 500 represent the equivalent of almost 200 of the smallest companies on the index. How does that imbalance affect the S&P 500? Is it intended?

Stovall: Yes, it is intended because a capitalization-weighted index basically takes the share price for each company and multiplies it by the number of common shares outstanding, and as a result, you then end up with the representation that each stock has within the overall index. Not all indices are capitalization weighted, however. Some are priced-weighted, such as the Dow Jones Industrial Average, but most of your indices, and particularly the S&P 500, is capitalization weighted.

I've used an old question that states, "When does 10 percent equal 50 percent?" The answer is when you're dealing with a capitalization-weighted index because the top 50 companies, which represent 10 percent of the total index, actually are 50 percent of the weighting of the entire index. Most recently, people have been talking about Apple (AAPL) and the concern about its weighting within the index. Adding to that the value for IBM (IBM) and Microsoft (MSFT)--the three largest tech stocks and also all in the top four within the S&P 500--those three companies together have a more than 8-percent weighting and represent a greater percentage of the overall index than 190 of the smaller stocks in the S&P 500. So yes, people are going to be seeing an outsized influence on the index's returns based on the size of the component companies.

EQ: We've talked about equal-weight indices here before. Why would investors want to consider equal-weighted indices or portfolios versus their traditional cap-weighted counterparts?

Stovall: The first reason is because they want each of the companies to have an equal representation in the performance of the index. Also, when you look back to the performance of the equal-weighted components as compared with the cap-weighted components, what you'll find is that since 1999, the U.S. large cap, mid cap, and small cap indices have seen outperformance by the equal-weighted indices as compared with the cap-weighted indices. This is also true internationally. The developed markets index has done better using an equal-weighted approach as compared with a cap-weighted approach, as well as the emerging markets index.

The reason why we are revisiting this discussion about equal-weighting versus cap-weighting is because everyday new investable options are being introduced that look at equal-weighted portfolios in different ways. It used to be just the S&P 500 that had an equal-weight component, but now the mid cap and small caps do, and along with that you have the developed, international as well as the emerging markets.

EQ: From a sector standpoint, adjusting from a cap-weighted index to an equal-weighted index means a significant change in representation for some groups. Can you tell us more about that?

Stovall: When you are looking at the S&P 500, the weighting of the overall index obviously does not change. But when you do look at sectors that have seen the greatest increase or the greatest decrease in representation, it has been pretty dramatic. In particular, as of April 13, the equal-weighted Consumer Discretionary, Materials, and Utilities sectors saw the greatest percentage increases in weighting. While the equal-weighted Consumer Staples, Energy, and Telecom sectors showed the largest reduction in weightings. The biggest sectors within the equal-weighted 500 index were Consumer Discretionary and Financials, whereas the largest sector within the cap-weighted 500 was Information Technology.

In terms of over-representation, Technology is close to 21 percent in the cap-weighted index, and is larger than any other sector's exposure in a cap or equally-weighted sector approach. And while five sectors in the equal-weight 500 -- Consumer Discretionary, Financials, Healthcare, Industrials, and Technology -- have a low-to-mid ‘teens representation, none represents as much as the cap-weighted Tech sector.

EQ: Has there been any consideration in reassessing how tech companies are categorized going forward?

Stovall: I've had several people ask me if we are embarking on another tech bubble like what we saw in the late 1990s. Other than several of the large-cap tech stocks like Apple and Priceline.com (PCLN) doing exceptionally well, I would say that we've had an awful lot of investor enthusiasm and hype on a sub-industry level, such as in social media. While I don't see them being carved out of the Technology sector since they are technology related companies, it certainly does show that though the overall sector itself might not be in a bubble environment, select companies or certain sub-industries can be the focus of investor enthusiasm, which could have a ripple effect on the overall sector.

EQ: Do you foresee the Technology sector being split into two different groups similar to perhaps something like Consumer Discretionary and Consumer Staples is grouped?

Stovall: I am not privy to what goes on in the S&P Indices area, but could they split them apart or bring certain sub-groups into Consumer Discretionary? In a sense, they already have. Amazon (AMZN), while it is regarded as a tech company by some, it is actually found in the Consumer Discretionary sector. And the same goes for Priceline.com. The reason is that one of the sub-industries within Consumer Discretionary is Internet Retail. So even if you find that a company has a business performed via a computer, handheld device, or other types of technology, it doesn't necessarily make it a company that is assigned to the technology sector. It's what the business is trying to accomplish that determines how it is categorized.

In some ways, however, tech-oriented companies are already being parceled out, and internet retail is a very good example. And if we find going forward that other tech-oriented companies are pure plays or dominated by one area that is not necessarily technology, then I think they, too, would be moved over into whatever sector they are most closely aligned.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
IBM International Business Machines Corp 159.89 -0.13 -0.08 2,909,546
SBRAP Sabra Healthcare REIT Inc. 7.125% Preferred Series 25.00 -0.04 -0.16 3,038
AAPL Apple Inc. 109.05 -0.86 -0.78 29,252,246
PCLN The Priceline Group Inc. 1,501.01 28.01 1.90 304,966
AMZN Amazon.com Inc. 760.05 19.71 2.66 3,944,100
MSFT Microsoft Corporation 60.28 1.03 1.73 18,401,799

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