By Tim Courtney, Chief Investment Officer
It used to take decades for a company to grow its stock capitalization by hundreds of billions of dollars. But today, for a handful of the largest companies, this has happened regularly for a few months. As we’ve discussed, the US stock market has become much more concentrated in its ten largest companies than at nearly any time in the past century.1 This has changed the nature of the market cap-weighted indexes like the S&P 500 Index and has affected the daily behavior of stock prices. Because of this, industry leaders are making or proposing changes.
One potential change pertains to options. A force that may have contributed to moving the largest stocks higher has greatly increased options trading, particularly zero-day-to-expiration (0DTE) short-term options with a week or less expiration. This activity is often highly speculative as traders bet on short-term price movements without regard to company fundamentals. Some traders may borrow and use leverage to magnify their positions throughout the day and clear their books before market close.2 To curb this, the Options Clearing Corporation has proposed recalculating margin limits every 20 minutes during trading days.3
One change that has been made is Morningstar's recent update to their methodology for classifying stocks. Traditionally, the S&P 500 has been viewed as a U.S. large-blend index with a balance between growth and value stocks.4 However, as large tech companies have grown in size and market dominance, the index became skewed and actually appeared to be more of a growth-oriented index rather than a middle of the road index.5
However, Morningstar altered its methodology for defining stocks as growth, blend, or value and also reset where the “center” of the market lies.6 Voila, the S&P 500 Index was pushed back to the middle of the road. We can understand the impetus for doing this, but some useful information is lost with this change. An index and market that is quite concentrated and quite expensive by historical standards is more normalized under the new methodology.
For several reasons, much of the U.S. large-cap market has become quite large and expensive. As price is a significant determinant of future return, we must be disciplined and mindful of the prices we pay for stocks. When we don’t, we become more like the anecdote about the sardine traders. As the story goes, traders had a good run as sardine prices consistently increased. One day, a trader decided to treat himself to a can of sardines from the warehouse but found they were rotten. After informing a group of traders about this, one of them responded, “Those are not eating sardines. Those are trading sardines!”
Turning from sardines back to stocks, most U.S. large-caps are thankfully producing profits and growing. But it is true that price can sometimes run far ahead of actual utility and value. If you have any questions about this, please contact your Exencial advisor.
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The S&P 500® Index (S&P 500®) is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.