The S&P 500 Is Highly Concentrated | Should You Be Worried?

[00:00:00] Welcome to Two Quants and a Financial Planner, where we bridge the worlds of investing in financial planning to help investors achieve their long-term goals. Join Matt Zeigler, Jack Forehand and me, Justin Carbonneau, as we cover wide range of investing and planning topics that impact all of us and discuss how we can apply them in the real world to achieve the best outcomes in our financial lives.

[00:00:30] Maybe holdings of clients, ability capital or some point investments.

[00:00:33] All right guys, say we are going to talk about something that I think is on a lot of investors' minds and that's sort of how big or how concentrated the market has become.

[00:00:45] And the reason this is something that's front and center is particularly for most of last year, the market was being led by a handful of stocks.

[00:00:54] Obviously investors have heard about the magnificent seven and those are the largest companies in the market today.

[00:01:02] That includes Microsoft, Apple, NVIDIA, Amazon, Meta, Alphabet and those are the ones that are in particular NVIDIA which just announced I think it was their latest earnings results.

[00:01:15] It was 126% year-rear sales growth, ridiculous earnings growth and NVIDIA is now the third largest company in the market and it kind of has gone parabolic here.

[00:01:25] But I think for today's discussion, you know, it's a combination of looking at this, looking how much or how large of a portion these companies are in the market today, kind of thinking about how that might stack up to where we've been historically.

[00:01:44] I'm a huge fan of Ben Carlson who is over at Ritt Holts and writes a wealth of common sense.

[00:01:51] I try not to miss any of Ben's articles, some of the stuff we're going to talk about is going to be sort of springing off some of Ben's excellent stuff that he puts out over there.

[00:02:02] And then just thinking about from an actual investor perspective, whether you're an investor like we are building investment strategies that are trying to outperform the market or from that perspective of planning perspective and working with clients sort of how he thinks about it maybe some of the questions he's getting and sort of just have a discussion about this because I think there are times when this becomes more front and center in investors minds and sort of that's where we're at today.

[00:02:31] So I mean, maybe let's just start with what the facts are so let's look at and I think we're going to if you're listening to us on audio, we are going to have some charts in here.

[00:02:41] So of course it's always nice if we're referencing charts to pop over YouTube if you can do that.

[00:02:46] But we're going to start just by looking at, you know, how big these companies are in the market today.

[00:02:53] So let's start there guys. And I know we have the chart here and just look at some of these percentages and sort of will start by ripping all that.

[00:03:01] Yeah, and the first thing I think we should talk about before we get into this is there's always these things and investing where everybody's like X is true so therefore it's time to panic.

[00:03:09] And this is one of those things. This is this idea there's over concentration in the market.

[00:03:14] So therefore it's time to panic and you know, one of the things we want to do with this episode is get the facts on this. Look at both sides of this because almost almost always when you hear things like that there's nuance to it.

[00:03:24] There's both sides to it. There's different things going on. So I think that's a good place to start and to your point, like looking at the top 10 holdings there will have them up on the screen but you do have a lot of, you know, you got first of all holdings with very high percentages Microsoft 7% Apple 6.22%.

[00:03:40] This is the SPY ETF we're looking at right now. You know, Nvidia's up there Amazon, you know a lot of companies that would be considered technology companies although with the industry reclassifications are not all of them aren't technology companies officially.

[00:03:51] But yeah, you have significant concentration in the top holdings of the S&P 500 and we'll talk later about how that compares to history but yeah it is something that's going on right now and it's certainly weighted in the technology area relative to other areas of the market right now.

[00:04:06] Another interesting thing that I saw here that you guys may not have, you know realize either is like look at number 10 on this.

[00:04:14] And also think about what companies not here like in this top 10 that you think would be.

[00:04:20] Let's see what company's not Tesla.

[00:04:23] Yeah, so calm is bigger than Tesla.

[00:04:26] That's something I never would have thought. I mean obviously Teslas had, you know, had some bad performance recently.

[00:04:31] I guess as was pointed out to me Matt on the breaking news podcast once Elon got the pay package.

[00:04:36] It was time to get the time to do stop doing whatever he was doing to keep the stock up and it's back down now.

[00:04:41] But that was interesting to me that like I would have guessed you know Tesla was still in this and I would not have guessed Broadcom, you know because of the rally and those types of stocks has become bigger than Tesla.

[00:04:51] When I look at a chart like this where I see a table like this and we have conversations about this stuff all the time with with planning clients and certain inside of our investment committee.

[00:05:01] You can't mistake confidence for overconfidence. That's the risk.

[00:05:06] You don't just want to assume because this is historically big and we're going to talk more about that than that automatically means bad because the problem is like you don't you don't know it's overconfident until it's in the review mirror.

[00:05:19] Right now though take this as a symbol of a symbol and signal of extreme confidence in these names. There's a huge lack of uncertainty here and this is not to ring the alarm or say be careful about this but I remind you of Wiley Coyote when he runs off the cliff.

[00:05:35] That's the thing people are going to make you scared of and that's the thing you have to remember too.

[00:05:40] Sometimes you Wiley Coyote out over that cavern and you don't know it until you look down and great companies a lot of confidence but just much tell us a little bit about what's going on historically with some of the stuff.

[00:05:55] Yeah, before we move on to that though let's just you know Jay Taylor who we've been on the value after our podcast he had a tweet.

[00:06:06] It was right after the Berkshire Hath Buffett's letter came out and it was like what are the chances that Berkshire Hathaway is you know the top company in the S&P 500 over the next five years.

[00:06:19] I thought that was like his history was basically there it's not an impossible scenario that Berkshire Hathaway will be the only trillion dollar company.

[00:06:28] Right, that's what was mine and I think you put it up to try to generate some controversy but the idea is like all these companies could become not trillion dollar companies and Berkshire could be the only one and I don't know just enough to have your head like how many of these are trillion dollar companies are they all.

[00:06:42] I believe maybe the tail end ones are not yeah, I think that's probably true.

[00:06:51] Maybe Eli Lilly and Broadcom we'll have to look but but yeah, that's a good that that is what he was kind of going after you could certainly see because Berkshire has like what they have 160 billion cash something like that and obviously it's a much more bricks and mortar type business

[00:07:08] I mean that you have insurance in there and there's obviously other financials but you know the actual private part of Berkshire's business.

[00:07:15] I think they might be like the largest public employer in terms of headcount and I know for a fact they're the largest pair of federal income taxes.

[00:07:25] So just when you look at these companies, you know what does stand out to me as you have all the tech there.

[00:07:32] You know little healthcare and then you have Berkshire Hathaway which is basically a conglomerate type of company.

[00:07:38] Yeah it was interesting he wasn't saying he wasn't saying that's what's going to happen he was saying like it's a non zero chance that's going to happen.

[00:07:45] And if you look back to like something like 2000, it would tell you it probably is a non zero chance if we had some sort of.

[00:07:51] You know tech driven bear market a lot of these names you know that are above Berkshire right now or all the names that are above Berkshire right now are tech companies so the problem is it would be like if you look at the decline it would take in like a Microsoft it's a major it's not like a 20% the client and Microsoft that gets it there.

[00:08:06] It's a major major decline so you'd have to have a serious issue going on but it's it's not impossible that you could have a situation where all these tech companies fall simultaneously and you know some other more old world type companies.

[00:08:17] End up being bigger if and certainly not the probable scenario but there's a lot of different ways the world can play out in the future yeah no forget the fractions of it all like just because they're declining doesn't mean everybody else isn't right like you could have.

[00:08:31] Tech companies getting halved but if everybody in the market is getting halved at the same time these numbers aren't changing so there's the relative differential on a tech company getting halved and you know an energy company or materials company or utilities company at the bottom how much do you have to go up to.

[00:08:52] Actually game ground in this table when when performance is relatively different that's something is allocators were wrestling with all the time thinking about this stuff because correlations among sectors yes there's differences but they run high when there's a nasty market event.

[00:09:08] Yeah you would need like a 2000 type scenario for that to ever happen you need a scenario where basically like your value type companies are going up during a massive bear market in tech and you know people want to think about that because it's in recent history but it's probably unlikely.

[00:09:22] You're going to see that again we'll talk about some of the differences as we go here but it's probably unlikely but again the thing I've learned like without a butler on the podcast is there's a bunch of different ways the world can play out it's only going to play out one way but there's a lot of you know if you think now into the future of all the potential ways it could play out.

[00:09:37] There's a lot of them and you know probably a tech driven bear market is one of.

[00:09:40] Yeah and it's just like in history where we saw tech runs up then spends close to a decade in the toilet while financials and things like that run up and then the financials spend another decade in the toilet while tech runs up again and I guess continues to run up this these trade offs are important in understanding the relative balances amongst them is hugely informative this because it tells you how hard it is.

[00:10:04] So let's just look at the sector chart real quick and there's not going to be any surprises is here you know information technology is 29% of.

[00:10:13] The index what I don't know I believe Amazon might be categorized in communication services so I think you might have to lump that in possibly.

[00:10:26] So would make it even the only point I want to make here is that you know if you're buying something like the S&P 500.

[00:10:33] This is obvious you know you're going to have a big allocation to technology given what you know given the weights of these companies.

[00:10:43] So to your point like sector allocation probably matters less than it ever has right now because there are a bunch of companies that most people would think are technology companies some of these big companies that actually are at other places like I believe Tesla is also in a different place.

[00:10:56] You know in terms of communication services and some of these other sectors that have been created.

[00:11:00] It's not the weight to actual technology is probably higher but also like what even is a technology company these days and everybody's using technology to some degree.

[00:11:10] Like what is it is Amazon a technology company I don't mean yeah it is but it also has a lot of other stuff it does and that's the same thing with like it's Tesla tar maker or technology company or some of these companies that traditionally wouldn't be considered technology are they using.

[00:11:23] Technology so much in their business that they have a hyper percentage of technology so to me like this is this sector thing is less relevant than it's ever been because it's just it's very hard to classify what these companies are.

[00:11:34] But definitely these big what people traditionally consider technology companies are a big part of the index right now I mean I think that's the conclusion from this.

[00:11:42] The gix sector changes and fully encourage if you've never done the deep dive into the history of the gix sector changes and how things are defined wildly enlightening like when financials even got added to the S&P 500 for example

[00:11:55] and all sorts of stuff like that and yeah tech Amazon I think move from technology to I want to say it's in consumer discretionary yeah that might be right I was thinking meta I think I should I miss spoke there I think met a might be meditation services but you know yeah so these gix things they're not I don't want to say their arbitrary but to make a sector driven argument about something you better understand.

[00:12:15] Understand all the fine details of how where stuff lives because yeah that's a tricky piece to and perhaps one of the most fascinating parts about this chart and looking at it or the first chart looking at where we are today with those stocks is how many of these fall closer to the definition of what we consider conglomerates or companies that spill in the multiple sectors at once.

[00:12:38] And that's a really interesting way to conceptualize this whole thing to remember we had Chris Davis on Justin and we talked about sector concentration.

[00:12:45] What is the point yeah he's point was basically that he doesn't care about sector concentration like he looks at the different things that can happen in the world and he looks at the exposure of his businesses those things but back to my original point he was talking about like it doesn't really tell you looking at these things in like trying to think about the risk of your portfolio probably doesn't tell you very much because there's so many different types of diverse companies.

[00:13:07] Inside of these different sectors that you're probably better off like doing something like he does where you're actually looking at the companies and you're looking at the risks to the companies and you're looking at how correlated.

[00:13:16] That is a crusher portfolio then you're you know taking these basic sector allocations and trying to figure out how they impact your risk most managers most portfolio managers in their construction are likely thinking at least most that we talk to are thinking more on those terms it's less about sector concentration or sector exposure granted there's lots of people who will manage the risk of the risk.

[00:13:37] They're going to have a manager fund and use sector exposure to help make sure they cover the beta of the S&P or whatever their benchmarking against.

[00:13:44] But in many cases if you're building up a bottom up fundamental model of a company you're thinking about what macro things hit this company in different ways just like for Amazon there's a big difference between consumer discretionary

[00:13:56] and what you know my wife and I order that shows up at our door every single day and Amazon Web Services and what's going on in the cloud and all the other different divisions these are well nuanced companies and a good fundamental model if that's your jam probably you're thinking in those terms.

[00:14:15] So let's talk a little bit about like the drivers of how these companies got there for a second and I think there's a couple points Jack that you want to make but one of the things that I was thinking is if you think back to the first half of last year with these big technology companies when Silicon Valley bank was going down and you had all these hard landing type of predictions and everyone was cautious.

[00:14:43] A lot of investors to me at least tell me to you guys agree with this it's almost like they looked at these technology companies and I think Doug Clinton and Gene Munster made this point with tech it's almost like they were being looked at as like consumer staple white companies in the sense that their technologies and things that people can't live without.

[00:15:04] And so to some extent their business models and their profitability was somewhat protected even during difficult economic times because how much how embedded these companies are into our daily lives so that's just one like observation sort of looking back at last year that I would say that how I thought you know investors were kind of looking at these things.

[00:15:28] That's such an important point because it's people think the word technology and they think risky sometimes and you know back in 2000 that was true but technology a lot of these companies are not the up and coming companies anymore you know crypto or whatever is where the high risks it's or whatever it is these days you know these are legitimate businesses and remember we had a podcast guest on who talked about this idea that they find protection now like when they want to find protection for tough times and their portfolio.

[00:15:54] They don't find it in the balance sheet of a company anymore they find it in the quality of the business and they were talking about how that's so important with the Microsofts in the apples of the world and why they do well now in these risk off types of events because these are solid businesses like you know people are not.

[00:16:09] People need Apple products at least for now I mean who knows 20 years from now someone's going to supplant apple but right now people need these products and so like that is so important is like thinking about this don't think this about this from the perspective of technology and risky you know think about the quality of the world.

[00:16:24] So the quality of the actual businesses themselves I think so much in terms of so when people are worried about a recession or worried about a crisis or whatever else and start to reallocate based on these shifting sands of confidence a lot of times what you're looking for is.

[00:16:41] What's what scares and if we're scared about a recession we're usually scared about the consumer or 18 other you know Silicon Valley bank or whatever the last giant major fear was or the Fed anything about what scares.

[00:16:54] And things are scarce you look for where like in a recession growth is scarce so you look for places where they're still growth and what's amazing is what we think of as these technology companies in many cases for the better part of the last decade plus post financial crisis these have been the shining beacon conglomerates that have not had a problem with growth as a as a scarcity.

[00:17:19] Look no further back than the pandemic and everything that happened it's like okay well everybody needs to stay at home so everybody needs more internet everybody needs to reshift their like spending and get their Amazon deliveries so there's that on the consumer discretion shift.

[00:17:34] These are growth scarcity stories that have just become funneled and funneled further and further good corporate capital allocation strategy into a handful of names jack to your point they've become safer in the sense that people have become more comfortable.

[00:17:49] So you know what I'm confident in this is where you can go and find growth when it's hard to find it anywhere else.

[00:17:58] Yeah you know I didn't answer Justin's original question because I never do and I always ramble off on some some tangent but as you should to your point what Matt was saying is like these businesses are a big portion of the S&P a large driver of that is they've done really well.

[00:18:09] These are really good businesses these are high margin businesses these are businesses that make money and they're growing you know it rates that you typically would never see on companies this bit they're sort of challenging the idea that when you get to a certain size you can't grow with these rates anymore we're seeing like technology companies or I don't want to use the word technology because I'm kind of contrary to myself earlier but these types of companies we're seeing them growing at rates you wouldn't think they'd be able to sustain so the biggest driver to me why there's such a big portion of the index is because their businesses are doing really really well.

[00:18:39] There's obviously other things that are peripheral to that you know we had Mike Green on recently and certainly I think the rise of passive investing in the fact that there's a lot of money going into indexes that doesn't care about fundamentals and they're investing most of that money into these big companies in that their liquidity doesn't scale with their market cap that is probably contributing to this to me I would consider that like a secondary contributor to this but I still think the primary contributor to this is that these companies are doing well and their businesses you know deserve to be big percentages of the market we can debate what percentage it is but they deserve to be big percentage

[00:19:09] is because they've good businesses. Everything's running into them that's the Mike Green passive argument which was a fantastic episode by the way I'm really embarrassed that I heard that after we did the David I don't have a

[00:19:20] said because of how good it was but yeah so so what so there's a passive tailwind into these things these are still big companies putting up big numbers and it's like you can get upset like I can be upset that I'm not the top center in the NBA but like the results show I'm not in the NBA I'm not that tall

[00:19:38] not even that good at basketball so hence stock 499 in the S&P if there is even is a 499 stock today I don't know if there's 500 names in the index today

[00:19:49] but versus you know number one through 10 who are just crushing it with their numbers

[00:19:54] so before we talk about history a little bit and don't bring bring up the chart yet guys I have a question for you

[00:20:01] and this is referencing back to a 2019 Jason's drag article so how many stocks going back to 1926 do you think have had the highest valuation or been the number one rated stocks in terms of market cap in the US

[00:20:20] how many stocks like how many total companies so yes have been the biggest have been the biggest company and how many years are we doing this over going back to 1926

[00:20:30] couple years couple age no no cheating no cheating it only gets back to 80 though that doesn't help me going back further than that

[00:20:38] I mean I want to say 10 just because we got about 10 decades in there and it feels like these things flip every so many years

[00:20:45] but I I'm expecting to get fully slapped by some gross small number

[00:20:50] is this like the price is right where I like have to get the rating over so

[00:20:53] sure because you pick nine basically you're winning right now is it 11 I need to say or nine I always forget the way it works

[00:20:59] depends on the way it's used I don't even know so yeah I'll go with that I'll go

[00:21:04] while you're not gonna wait because Matt nailed it but he did seriously so yeah so there's 10 stocks sure

[00:21:11] they are Microsoft Apple X on general electric Walmart Altria which was formerly still at Morris IBM

[00:21:20] Dowdupont general motors in AT&T um and I was split I know you're gonna show the chart is it split by decade or

[00:21:27] is there like trading off it on like how well yeah that really was just a dumb guess that yeah let's look

[00:21:34] yeah I mean no it's you kind of have you kind of have these clusters like you know IBM as we you

[00:21:39] guys can see you know in the 80s and the 90s and then general electric as we all know in the 90s

[00:21:44] in the 2000s remember Jack Welch and then ML and their roll up and and Welch with all his

[00:21:49] management books and stuff and an exon pops in there and then it's been Apple since 2050 and now

[00:21:55] Microsoft is you know barely edged out Apple in the current shape uh current day but one of the

[00:22:01] things that always I always I always love that Jason's Rye article because in I think IBM or no

[00:22:09] I'm sorry AT&T might have been what is the statistic in here let me check this out a bit um at one point

[00:22:19] AT&T was 13% of the total US stock market that was before it was you know pre baby bells

[00:22:26] yeah before it was broken up and stuff like that and I think like when you look back in the 40s and

[00:22:31] it had like a massive long run of just being most dominant company um in the country from a market cat

[00:22:39] perspective um and so anyways we'll we'll put a link to the article is uh title what Amazon's

[00:22:46] rise to number one says about the stock market he kind of looks at the history of sort of the market

[00:22:51] and sort of sort of what we're talking about I'm still recovering by the way from the back of like

[00:22:55] Jack Welch was not a good CEO because like when I was growing up that was like dude he was

[00:22:59] like every book was Jack Welch like everything was like he's the greatest thing of all time and now like

[00:23:03] well as a fellow Jack you must thought he was as a fellow Jack you must have felt like this is

[00:23:09] like your birthright I was very upset by this like I was reading his books when I was like you

[00:23:12] know coming out of college like all the stuff I had to learn to run a great business and then suddenly

[00:23:17] he's not good um man it was a big adjustment for me but anyway we don't we don't need to get my uh

[00:23:21] we don't need to get a good deal yeah but I think I think the the key take away lessen

[00:23:27] for me there's two things one it's no company is going to be on top forever it's just not I don't

[00:23:33] believe that that's possible there's always the competitive it's like the Joseph Shumpeter or the

[00:23:38] perennial gale of creative destruction you know these companies are highly profitable but their

[00:23:43] businesses are always being coming under attack and so is their profitability and and the other

[00:23:48] thing is yeah this is one of the arguments for you know for why passive investing sort of can work

[00:23:55] for a lot of people because you just naturally you're gonna get exposure to the companies that are

[00:24:01] growing the companies that are winning the companies that are becoming more profitable because

[00:24:05] ultimately you know jack back to your point if fundamentals matter which they should over time

[00:24:10] you know those companies are going to rise to the top of the index and the other ones are going

[00:24:13] are going to fade away um so I don't know what I don't know what you guys think about that stuff but

[00:24:19] that's kind of where I'm at yeah you know there's there's a there's a bunch of different takeaways from

[00:24:24] this that are interesting to me like in terms of looking we should probably put up the chart now for

[00:24:28] the top 10 holdings and the S&P over time like like you said I mean the companies it's interesting

[00:24:33] they'll persist for a while they won't persist for that long I mean I'd be made it for three

[00:24:37] decades it was or three decades basically one decade um general electric was on here three times

[00:24:43] in a row you know apples been on here for a while it's interesting and you know also going back

[00:24:47] to our original point um you know we and I don't know if we said this explicitly but it's like it's

[00:24:51] like 32% right now is the what the top 10 holdings are of the S&P 500 so you know as you look at

[00:24:56] this chart you can kind of compare it to history um and it's not on here but there were periods

[00:25:01] where it was more concentrated um like the nifty 50 I believe was around 40% give or take um so

[00:25:06] we have we are not an unprecedented territory or the highest in history or you know if you see

[00:25:11] any of that stuff about like you know build a bunker in your backyard because it's all over um you

[00:25:15] know we're not at that but we are very high you know relative to some of these other things and

[00:25:20] you know what's interesting is as we think going forward is you know first of all like look at some

[00:25:24] of these companies I mean a lot of these companies don't even exist right look at 2000 I mean you

[00:25:28] know you have I mean you have AIG in there um Cisco's not I don't know what Cisco's waiting is now but it's

[00:25:37] you know yeah you can take any of these any of these you know any of these lists and you can see

[00:25:42] companies that have you know fallen fallen off or maybe aren't even around anymore

[00:25:46] yeah and that's the hard thing about this is you think like in the moment in the moment today

[00:25:52] like if you look at the list of you know this is from 2023 this is from Ben Carlson's piece but if

[00:25:56] you look at those names like you'd have a hard time coming up with one of those names that you think

[00:26:01] is gonna be like way way smaller in a decade I mean those all all those names have a pretty good case

[00:26:06] I mean maybe Tesla but uh so they all have a pretty good case that they're a pretty solid part of

[00:26:11] our economy um and you should be going forward but did you feel the same way in 1985 you know when

[00:26:17] you looked at IBM and the Exxon and General Electric and you know Dupont and whatever did you feel

[00:26:21] the same way then Sears by the way a great example like that didn't end well um so like do you

[00:26:27] it's just interesting to think about as we think about where we are now like trying to put yourself

[00:26:31] back in those times and say would I felt the same way about those companies that I feel about

[00:26:36] the apples and the Microsoft's today and how many times do you think and granted I don't know this but

[00:26:42] it's when you see these names like leveling off sometimes it's just because the person lower

[00:26:48] just was rising faster than the one who was on top like these aren't all like it's not the tree

[00:26:54] grows to the sky that's one rule trees don't grow to the sky you get to a certain limit there's natural

[00:26:59] limits but then the other reality here is it's not like you get to the top and then you go off a cliff

[00:27:04] you don't fall just because you had some catastrophe you don't get AIGed

[00:27:10] he's like the financial crisis thing a lot of these companies they just stopped growing as fast

[00:27:15] as whoever else and somebody else right with a new trend or whatever else it doesn't mean that

[00:27:19] these companies were killed see AT&T as just one of a million examples in here

[00:27:25] and that's another interesting thing on this chart like most of a lot of these companies are still

[00:27:29] around at some capacity I mean Cisco is not one of the biggest companies in the S&PF 100 anymore

[00:27:33] but it's still there it's still running a profitable business that continues to exist to your point

[00:27:37] they just got passed by other people so it's not always a story of you know this ends in disaster

[00:27:42] you know a lot of these companies are still here and the proctor and gambler a lot of these

[00:27:46] companies are still here they just aren't the biggest companies other things change in the economy

[00:27:50] and another bigger companies took over you know there was a sears pretty close to my house

[00:27:58] and the place was just a dump and it's just you just towards the end this was towards the end

[00:28:06] but then what they did is they but you know sears had all those like great prime locations

[00:28:11] and so I don't know if Eddie Lambert was in there or something like that and then he kind of like

[00:28:15] was trying to repurpose and now the plaz is like amazing there's like

[00:28:21] um there's like a sax to savonoo off thing in there there's like a market place thing it's like

[00:28:27] they've done a really there's an REI that they put it in so it's really talking about yeah

[00:28:31] that turned around in that lot it was literally crazy crazy to watch and Connecticut as I got

[00:28:37] a re-engineered which a lot of sears did that when they were at least in a hub where there was

[00:28:43] commercial activity there's a lot of other ones right from go 20 20 minutes up the road on the highway

[00:28:48] from where you're talking about that sears and I could show you another one that's basically

[00:28:53] one of the many dead malls of america that miraculously was basically kept open by a radio shack

[00:28:58] and then a game stop but I think it's a good too long and thinking about what sears used to be

[00:29:03] or what jc pennies used to be in this in this country you know that used to be like Friday nights

[00:29:07] families would go in the 50s and 60s they would go to sears as a family they would shop you know it was

[00:29:13] and it just goes to show how much consumer behavior and trends and things can change over time

[00:29:20] you know now we're all sitting in front of our computers basically ordering everything off amazon

[00:29:24] you know and our kids have their own accounts and though you know no one's doing family shopping

[00:29:28] but it's a new conglomerate it's still a creep on right we have a diversion of it

[00:29:33] just saying you're bringing back big remune to my childhood because like one of my favorite

[00:29:36] things to do was when it became time to replace the appliances in the forehand house so we would pack

[00:29:40] the whole family into like the Volvo 740 turbo or whatever it was you would all head down there

[00:29:46] and like I could look at like 4,000 refrigerators like all next to each other and be like oh let's get

[00:29:50] this one or let's get this one like it makes me weird it was actually fun to do what's a fun thing

[00:29:56] to do is a brilliantly executed strategy and yeah I've got good memories to go in this years

[00:30:02] do we want to hit on the jack I think you would kind of start to look at this sort of the

[00:30:07] relative fundamental weights here without getting too specific just was there anything that you took

[00:30:12] away from that yeah no the idea basically is you know one of the ways to say is this justified

[00:30:17] is to say all right what's the market cap weight of these companies in the S&P and then what is

[00:30:21] the weight on fundamentals and depending on which which fundamental it can be different but you

[00:30:25] know those numbers the numbers based on fundamentals are in the teens or in the 20s and the actual

[00:30:30] weights are in the 30 so from that perspective these companies are trading like at they're

[00:30:35] trading at a premium to their fundamentals but the one thing to keep in mind is the part that's

[00:30:39] missing from those fundamentals is growth so if you look at like a garpt type thing you know you want

[00:30:44] to companies that are trading at higher growth rates deserve to trade at premium multiples and so

[00:30:49] these companies are also growing at a faster rate if you took the growth rate of these 10 companies

[00:30:53] against the growth rate of the 490 that growth rate is higher so they deserve to trade at a premium

[00:30:58] so it's beyond me to argue like whether we're the right place or whether these are overvalued by a

[00:31:03] lot or anything but the point is that's kind of the way to look at this is to say what are the

[00:31:08] fundamentals and when you look back to you know we've talked about 2000 that's where you see the big

[00:31:11] difference here like look at Cisco's multiple in 2000 relative to like Nvidia's multiple right now

[00:31:17] Nvidia trades at a premium multiple nothing like that and nothing at the hundreds of times you know

[00:31:21] earnings or whatever Cisco was trading at so it's just important when you compare across

[00:31:25] areas you can ask that question all right we've had these different levels of concentration but what

[00:31:30] were the fundamentals looking like behind the scenes in those different areas and in a time like

[00:31:33] 2000 you saw really extreme concentration you know relative to the fundamentals you need that

[00:31:39] reminder Jack it's got to be tied back to the fundamentals the fundamentals have to be tied to

[00:31:45] some story that's carrying this thing through on why people should care and in many cases we look at

[00:31:51] it through the growth lens and we say if if growth is scarce because in a post pandemic world

[00:31:57] growth was scarce we all wondered where it was going to come from at zero interest rates and all

[00:32:00] that stuff garpy or stuff tended to work better that got awarded with higher multiples we haven't

[00:32:05] really moved on past that yet and it's as true with companies as it is with anything else let me

[00:32:12] remind you of a of the other Cisco and his wonderful hit the thong song there was a place in time for

[00:32:20] the thong songs but it that ship eventually sales and you just got to be ready for that I was wondering

[00:32:26] what you're going to prepare for this episode man and that was not where I thought you were going to

[00:32:29] go that is not what I even thought to prepare for this and a little let down in myself because

[00:32:34] then this was not what you prepared this was random chaos and you're just lucky I couldn't

[00:32:39] work a Cisco food services in there too one of the I'm just gonna say one of the you know possible

[00:32:48] challenges for active investors that are trying to you know construct portfolios that beat the

[00:32:52] market is you know if you have shunned these companies and haven't had them in the portfolio

[00:32:59] you've probably largely trailed the index um you know maybe not in all cases but it's just tough

[00:33:06] if you don't have some exposure to these really top performing stocks you know there's a chance

[00:33:11] that you know you're going to be trailing the market and then and then that has a whole set of for

[00:33:15] you know active managers sort of challenges in terms of client retention and growing assets

[00:33:20] and things like that so that is just something that unless and the indexes for you know and this

[00:33:25] goes over time the indexes very hard to be net affees uh for most managers but I think this

[00:33:32] concentration sort of highlights that yeah it's been a challenge for both active managers and

[00:33:38] factor investors like lots of everything like you know go back to those weights we showed at

[00:33:42] the beginning like come up with a factor that gets me to there um like there's one factor you're

[00:33:47] going to come up with market cap they're not anything else like not quality or value or momentum might

[00:33:53] have got you there momentum might have kind of got you there though well not really because momentum

[00:33:56] is you know one year momentum so like as much as these companies have had sustained momentum over a

[00:34:00] really long period of time they've been in and out of momentum portfolios you know during that period

[00:34:05] so like unless you use like some crazy long term momentum or something which is not will work

[00:34:09] academically um you know a lot of momentum portfolios like the momentum funds we look at wouldn't

[00:34:14] well anything like this and they also typically wouldn't overweight the biggest companies so

[00:34:19] even if they had the momentum funds had the Microsoft's Minneapolis in there they're probably equally

[00:34:23] waiting them they're probably not you know holding seven percent in Microsoft. Well yeah it's just

[00:34:27] to that point you know you wouldn't you wouldn't have been in these at the end of 2022

[00:34:32] so momentum strategy would not have had these then it would have chased them back in as they

[00:34:38] performed in 2023 so that's a good point yeah it was interesting like I asked my green on the episode

[00:34:43] like if I wanted to because I'm always doing the factor nerdy stuff I want I'm like if I want to

[00:34:46] construct a factor to say all right if this passive investing is influencing the market and I want

[00:34:51] to say like what are the companies that have the most flows relative to their market cap you know

[00:34:55] relative to their liquidity could I do that and could I come up with something better than a market

[00:35:00] cap weighted index and his answer was pretty much no you know by owning a market cap weighted index

[00:35:04] you're owning the companies that are benefiting the most from these flows you can't break it down any

[00:35:08] further using like some detailed liquidity metric to get there so that this is just you know in

[00:35:13] order to match these indexes you pretty much had to own them or you had to be one of these tech

[00:35:18] investors who you know really focused on these big name companies and didn't own the rest of the

[00:35:22] index and you know those guys are are outperforming. Just curious if you have this great if not no big deal

[00:35:29] what's the percentage of Apple and Berkshire Hathaway's investment portfolio? Well I think he owns let's

[00:35:35] see so I can tell you real quick there's a CMBC has a Buffett tracker so you can see

[00:35:45] Berkshire Hathaway you can see I do like a headline for this now like Warren Buffett is the true

[00:35:53] beneficiary of passive flows or something? This is where I'm going with this. Well so let's see so Buffett

[00:36:02] as a 163 percent position, 163 billion dollar position in Apple his total equity portfolio is 369 so

[00:36:17] 160 over 369 is what? 163 divided by so 43% 369 yeah so other his stock portfolio

[00:36:31] and then Berkshire's market cap is basically 890 so of the 890 you know 163 is in Apple. So about

[00:36:40] it eighth a little over an eighth of Berkshire's overall total market capitalization is Apple stock

[00:36:49] which I find fascinating and I think this is important to remind people too like if Warren Buffett

[00:36:54] is the patron saint of value investing and he stands at odds with passive investors

[00:36:59] he's got a 43% portfolio allocation to Apple on that math approximately that's I'm stating this

[00:37:06] right guys right yeah say to guy yeah maybe you do it relative to the market cap but he has a huge

[00:37:12] yeah he has a massive massive position in Apple far bigger than the index does far bigger than

[00:37:17] the index and hey financial advisors out there if a client came to you with a 40% position in one

[00:37:22] stock what are you telling them and then do you want to fight the passive market fanboys

[00:37:29] the Warren Buffett fanboys or something else it's really interesting to think about this stuff

[00:37:34] and how it evolves even in you know Berkshire Hathaway which is on that top 10 list you know

[00:37:39] there's nobody's talking about the risk of over-concentration in Berkshire Hathaway everybody

[00:37:42] talked about over-concentration in the market right like who's lecturing Warren on this who's

[00:37:48] lecturing Warren on you got too much Apple buddy how dare you is this Jim Kramer am I

[00:37:53] diversified or what and he just doesn't care I mean he buffett does his own thing he could care

[00:37:57] really you can lecture him all day about his over-concentration in a position he could care less well

[00:38:01] back to the idea if you un and I'm using understand and air quotes if you understand the reason

[00:38:07] you're invested in something you don't have a crystal ball about what's gonna happen next but

[00:38:11] but if it's okay for Warren Buffett just digest that you know the other thing with these big

[00:38:18] companies and it kind of goes back to the ironhorn thing a little bit but I'm thinking of Buffett

[00:38:23] and Apple one of the things that he's highlighted a lot with his investment at Apple is that you

[00:38:28] know the company is better I don't know this year but the company has over the last let's say five

[00:38:34] years or maybe along with that then buying back its stock and a lot of these companies and I'm just

[00:38:40] trying to think of I think it was Jim O'Shaugh and see we had I don't know someone we've had in

[00:38:44] the podcast has talked about like some change in the like 1980s I think made it easier for companies

[00:38:53] to buy back their stock I think there's something like that like something in the legislation or

[00:38:57] something in the tax code or something I don't know exactly what but I'm just wondering if like

[00:39:02] that is also a big difference between you know what has happened historically with some of these

[00:39:09] companies and and what is happening now in terms of just more and more companies buying back their stock

[00:39:17] and how that plays into um you know shareholder value I don't know maybe maybe that's a

[00:39:23] discussion for another day just thinking out loud here the shareholder yield episode yeah I think

[00:39:28] that's interesting but it's another one that just it evolves over time there's no broad brushstroke

[00:39:33] of where no matter what well we're comparing top 10 market cap stocks today against five years ago

[00:39:41] let alone 50 years ago there's no apples apples comparison here there's just no way to truly do

[00:39:49] that all the way all we can say is these are the 10 biggest companies per this unit of measurement

[00:39:55] doesn't tell us a heck of a lot of what they have in common and yeah maybe for a future episode

[00:40:00] we'll play like what am I describing is it sears or Amazon and I bet I can go down the list and

[00:40:06] it would be astounding how many things would surprise us that you wouldn't see coming just because

[00:40:13] the world keeps changing and just one other point of over concentration before we move on it's

[00:40:17] when you are when you talk about the issue of over concentration you also have to talk about the

[00:40:21] issue of what are you concentrated in so if I want to have a 7.1% position and I'm worried about the

[00:40:27] risk of my portfolio I'm probably better off having Microsoft and Carvana you know so it is

[00:40:32] different like these are the biggest companies in the economy and that doesn't mean there's not

[00:40:36] a risk of over concentration because there is but if I've got a bunch of random small caps you

[00:40:40] know company of losing money and I've got 32% in my top 10 holdings that's a different portfolio

[00:40:45] than these companies that are like the central part of our economy so Matt I'm a client

[00:40:54] you're managing my portfolio you know I'm not working buffing are you no okay

[00:40:58] okay I'm gonna tell them to reduce his concentration is that your first thing I was getting scared

[00:41:02] to that I don't tell I'm going to work on that you know I come to you and I say I want to buy

[00:41:06] you know I want to buy the S&D 500 or I want to buy the NASDAQs you know because these have exposure

[00:41:13] of what I feel are great companies and maybe I don't see them in the portfolio now like how do

[00:41:19] you think about this from a client planning communication perspective goals first so no matter what

[00:41:30] unless you're coming to me and we're on an investment advice only contract where we're saying

[00:41:35] what are we trying to do for our pension portfolio whatever it is we're having a conversation

[00:41:41] about what why and how you want to do this thing and as I'm sure there's no surprise we have clients

[00:41:48] who have concentrated positions in many of these top 10 names because they've been massive

[00:41:53] beneficiaries of owning them for the last three five ten twenty years in some cases that's one

[00:42:01] of the things that happens when you invest in individual securities sometimes you get

[00:42:07] that will give you credit being really smart but you get really lucky on top of being smart enough

[00:42:12] to have had these things what that introduces is okay what do we want to do with it and the ongoing

[00:42:19] theme of this whenever we talk about it for the planning lens is consumption or a gift if you have

[00:42:26] more than 10% in a single security name usually we're going to have a conversation about okay with

[00:42:32] the other 90% of your wealth or more or less whatever it is what portion of this do we need for

[00:42:39] consumption what goals do we have to match against this and what risks does the concentration in

[00:42:44] the portfolio create that might endanger some of those goals this can happen in an individual stock

[00:42:54] this can happen it's very common to see this happen with real estate probably more common than with

[00:42:59] like an individual stock or sometimes in a cluster of stock what's most important is start to

[00:43:04] layer together we'll take it all the way back to that portfolio manager question that you brought

[00:43:09] up earlier about understanding like the layering of the risks I'm going to ignore what sector I have

[00:43:15] but I'm going to understand the layering of risks what if I have a giant long position in Amazon

[00:43:22] Nvidia and Exxon and I have loans out against those that are providing bridge financing to my

[00:43:30] company or my my real estate portfolio this meshing of the risks and understanding what type of a

[00:43:38] decline does what for my ability to consume or use this money for what I want to do and that becomes

[00:43:43] the bigger issue so there's nothing wrong with owning these things there's even nothing wrong

[00:43:48] with having a giant concentration to some of these things so long as you've done the rest of the

[00:43:52] planning around it and if one of them is going to puke on its shoes or fall out of bed or whatever

[00:43:58] is going to happen and it will happen what are we going to do about it likewise just as a reminder

[00:44:07] I feel like we've been talking about this for years too like these things are going to evolve

[00:44:10] so even if you have the concentration today doesn't mean they don't get spun out into 10 different

[00:44:14] things later you have a giant Google position what happens if all of a sudden in five years we have

[00:44:19] Google and YouTube what happens if Facebook on that chart there changes their name to meta what happens

[00:44:25] if I'm in Drew Hill and Drew Hill disbands and Cisco goes off and writes the thong song

[00:44:33] get your exposure know why you're doing it and just know what you're sticking with and what those

[00:44:36] risks are that's the conversation we're having I don't even remember Drew Hill that's that's a good

[00:44:42] that's a good deal we get deep cuts here deep cuts yeah it's me too on that mad is this idea that

[00:44:49] you know if this does accelerate I wonder how planners will think about it like it's an unlikely

[00:44:54] scenario but if we're looking at it five years from now or set or in we're like 60% of the S&P

[00:44:59] is in 10 companies or something like I don't think that's likely to ever happen but if it did it would

[00:45:04] be an interesting risk that's out there that is like a risk we haven't really faced which is

[00:45:08] people who are really in the S&P 500 who are doing the right thing by indexing face like a level

[00:45:13] of over concentration risk that typically would be reserved for other people running like these focus

[00:45:18] portfolios and like how do you think about that I think it'll be interesting to think through if

[00:45:22] we ever got that although I doubt we're ever getting there I doubt we're getting there I'll put this

[00:45:27] out there too because so legitimately since 2019 we've been talking about the nifty 50 like ad nausea

[00:45:36] and with clients since 2019 we've been talking about remember the nifty 50 remember the nifty 50

[00:45:42] you can't just play for pay for growth at all costs at some point it turns around to bite you

[00:45:47] and guess what we're in 2024 and this was exactly the thing you should have kept doing all the way

[00:45:52] through the pandemic if we get to that point and every financial planner can understand this I would

[00:45:59] think if you have people that have been investing for some period of time if people are just starting

[00:46:04] off and have never invested a dollar it's a different but if you're serving people I would say like in

[00:46:08] their 40s and up and certainly in their 50s and up whether it's an a passive fund or their Berkshire

[00:46:14] Hathaway position or they've gone out and they've bought some of these companies because they thought

[00:46:19] Apple was a good idea 10 or 20 years ago they're out there if we get to that position Jack where everything

[00:46:26] keeps lifting more that rising tide continues to lift these boats there's also a heck of a lot more

[00:46:33] profits to do something with one thing I know for sure the older people get in life and the bigger

[00:46:39] these concentrations get or the bigger these things happen the more they want to plan on what to do

[00:46:44] with it and that might be how to title it to do an efficient estate planning transfer to their kids

[00:46:49] because they want to gift it or a charity because they want to send it away while it's at a high

[00:46:53] watermark and not pay the taxes but if it keeps going up it just changes the nature of the planning

[00:46:59] conversations it doesn't change the nature of portfolio construction or the logic or the conversations

[00:47:06] that need to be had and the other point too is we don't know where we are in the cycle with this

[00:47:12] and that's so important and I want to put up this absolutely Cisco chart quick because it's just

[00:47:16] interesting I hate these charts by the way the compare like the past performance of one stock and put

[00:47:20] the present for another stock on there as if they mean anything but what this chart does get at

[00:47:24] is this idea and we're about to have Doug Clinton on our other podcast on excess returns to talk about

[00:47:29] the idea that he thinks we're in like 1995 in terms of like a comparison with the dot com bubble with

[00:47:33] AI so he thinks we're at the beginning of this it just shows that you know you think about how much

[00:47:38] Nvidia's run up and you compare it to Cisco back then and it could be early stages here it also

[00:47:44] could be the end of the road and it could roll over tomorrow but it's just interesting to think there's

[00:47:48] a lot of different paths here and just because we have over concentration or whatever we have doesn't

[00:47:53] mean it's not going to get a lot worse it also doesn't mean it's not going to go the other direction

[00:47:57] we really don't know but it was just interesting for me to look at that chart because it just tells

[00:48:01] me like how out of hand this could get a small obviously low probability type thing but these things

[00:48:07] could get way more out of hand than they are now asking for a friend end of the road was that a

[00:48:12] boy's to men reference I just caught it was not but I it would be my first actual pop culture

[00:48:16] references that came up with in the podcast if I did so maybe I could edit it back to make it look

[00:48:20] like I did say it that way well I believe I think that was earlier 90s and 95 but I think these

[00:48:25] scenarios in thinking through this stuff in this way is super super useful and the bigger way that

[00:48:35] I think about all this this is the thing I had in my head before recorded that wasn't Cisco the

[00:48:38] rapper and the thongs on I keep going back to that so you guys you've seen the magnificent seven you

[00:48:45] know the theme song you've seen the movie not the new one there was like a 2016 version not talking

[00:48:49] about that trash you seen the 60s movie the Magnificent seven I have your child since I am hopped

[00:48:58] in the delorean and coming to find you guys is getting with a copy of this movie because it's so

[00:49:02] friggin good it's such a great movie you got you got you all you all briner Steve McQueen's in it

[00:49:08] Charles Bronson is in it a whole cast of others and the premise of this movie is like this village

[00:49:13] is getting you know attacked by the bad guys so the village is getting attacked they go they go

[00:49:18] ask for help they find this rag tag groups of like drunks and bandits and like you know pistol man

[00:49:24] in there they're the magnificent seven and so these guys come into basically save this village from

[00:49:29] these like evil bandits but in the mix of it all they they kind of get like housed and they protect

[00:49:36] the villagers they teach the villagers to like protect themselves but a couple of them die like it's

[00:49:42] it's rough it's rough and in the parting shot to the movie the main guy in the village says

[00:49:49] to the departing like heroes who now have lost friends and everything else he's like the only people

[00:49:53] who really wanted this thing was the village the mag seven lifts it is like these 10 companies

[00:50:00] of these mag seven stocks were all obsessed with right now they're not like the winners the winner

[00:50:05] is us as investors like you have to be in the village don't be the bad guy don't be out there

[00:50:10] shorting all this stuff but you also don't have to be the mag seven and taking all names

[00:50:15] the village is what wins by not doing stupid stuff I was thinking that one could look at the

[00:50:22] host of this podcast as a rag tag group as well so that that might be another analogy to what you're

[00:50:26] doing I mean I really I like to think of I like to think of you as you old briner with the you know

[00:50:31] the the the shapes head and uh do you be Charles Bronson or I'm Charles Bronson just it is without a

[00:50:37] question Steve McQueen in this case oh well yeah I got the shirt into this

[00:50:43] hey they're good Charles Bronson's

[00:50:47] all right guys good stuff I think that's a good way to conclude it thank you guys for watching

[00:50:51] and we'll see you next time hi guys this is Justin again thanks so much for tuning into this episode

[00:50:57] you can follow Jack on Twitter at practical quant you can follow me on Twitter at J.J.

[00:51:02] Carbano and follow Matt on Twitter at at cultish creative if you found this discussion interesting

[00:51:07] and valuable please subscribe and either iTunes or on YouTube or leave a review or a comment also

[00:51:14] if you have any ideas for topics you'd like us to cover in the future please email us at access

[00:51:18] returns pod at gmail.com we would like this to be a listener driven podcast and would appreciate any

[00:51:24] suggestions thank you