Large and in charge.
Technology companies are drawing attention for their sway on share markets, but history undercuts that view.
A top-heavy US share market with the largest 10 companies accounting for over 20% of market by size and a marquee technology firm perched at No. 1?
This sounds like a description of the current US stock market, dominated by Apple and the other FAANG stocks, but it is actually a reference to 1967, when IBM represented a larger portion of the market than Apple at the end of 2019 (5.8% vs. 4.1%).
As we see in Exhibit 1 below, it is not particularly unusual for the market to be concentrated in a handful of companies. The combined market capitalization weight of the 10 largest companies, just over 20% at the end of last year, has been higher in the past.
Exhibit 1: Same Old Story
Weight of largest stocks by market size in US share market, 1927–2019
A breakdown of the largest US companies by decade in Exhibit 2 below shows some companies have stayed on top for a long time. AT&T was among the largest two companies for six straight decades beginning in 1930. General Motors and General Electric ranked in the top 10 at the start of multiple decades. IBM and Exxon were also mainstays in the second half of the 20th century. Hence, concentration of the share market in a few large companies such as the FAANG stocks in recent years is not a new normal; it is old normal.
Exhibit 2: Big Board
Largest 10 US companies at the start of each decade
Moreover, while the definition of “high-tech” is constantly evolving, firms dominating the market have often been on the cutting edge of technology.
AT&T offered the first mobile telephone service in 1946. General Motors pioneered such innovations as the electric car starter, airbags, and the automatic transmission. General Electric built upon the original Edison light bulb invention, contributing to further breakthroughs in lighting technology, such as the fluorescent bulb, halogen bulb, and the LED. So technological innovation dominating the share market is not a new normal; it is an old normal too.
Another trend attributed to a new normal is the extraordinary performance of FAANG companies over the past decade, leading some to wonder if we should expect these companies to continue such strong performance into the future. Investors should remember that any expectations about the future operational performance of a company are already reflected in its current price. While positive developments for the company that exceed current expectations may lead to further appreciation of its stock price, those unexpected changes are not predictable.
To this point, charting the performance of companies following the year they joined the list of the 10 largest firms shows decidedly less stratospheric results. On average, these companies outperformed the market by an annualized 0.7% in the subsequent three-year period. Over five- and 10-year periods, these stocks underperformed the market on average.
Exhibit 3: Power Down
Annualized return in excess of share market after joining list of 10 largest US companies, 1927–2019
Past performance is no guarantee of future results
The only constant is change, and the more things change the more they stay the same. This seems an apt description of the dominant companies atop the market.
While the types of businesses most prominent in the market vary through time, the fact that a small subset of companies account for an outsized portion of the share market is not new. And it remains impossible to systematically predict which large companies will outperform the share market and which will underperform it. This underscores the importance of having a broadly diversified equity portfolio that provides exposure to a vast array of companies and sectors.
[Adapted from an article by Dimensional Fund Advisors and its affiliates, June 2020.]