Most stocks produce lackluster returns. A recent study1 by Hendrick Bessembinder, a professor at Arizona State University’s WP Carey School of Business, looked at U.S. stock market returns from 1926 to 2022. Nearly 60% of all stocks detracted from shareholder value during this time period. From 1926 to 2016, half of the total wealth created in the stock market was produced by only 90 stocks. By 2022, the number was only 72 stocks.
Not just a local phenomenon, a similar pattern emerges among stocks around the world. In a separate study2, Bessembinder showed that only 2.4% of the 64,000 stocks from around the world created 100% of global market wealth during the 1990 to 2020 period.
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So far this year, the trend has accelerated. Recent results indicate that nearly 90% of the year-to-date return of the S&P 500 has come from only seven stocks – the so-called Magnificent Seven mega-cap tech stocks. The other 493 stocks have provided almost zero value. Small-cap stocks as a group have produced negligible value.
Reflecting their long-term performance dominance, the Mag Seven stocks now represent nearly 30% of the total market value of the S&P 500 – a concentration almost unseen in the index’s history.
Taken to its logical conclusion, all of the gains in the stock market would be generated by only the single largest stock. All of the others would have flat, or negative, returns. What once may have been an extrapolator’s fantasy is nearly reality today.
If this trend continues, the only worthwhile strategy would be to own only the largest and best-performing stocks. This could have huge implications for investing. First, it would argue strongly against diversification. If only a few stocks will work, then all of the others will be money losers, so why drag down returns by owning them? It’s a bit like football’s “Prevent Defense” strategy used by a winning team’s defense to prevent the opponent from scoring late in a game. This term was dropped when coaches realized that the only thing it prevented was the defensive team’s victory. Diversification would simply become “diversifying away your profits.”
Another implication would be to render useless any investing approach other than owning the largest and best stocks. Value, small-cap, quality, momentum – all would become average performers at best, and eventual losers as more money migrates to the small handful of winners. Money chasing the winners would leave all other stocks starving.
For the remainder of this year, we could readily see this trend continuing. The Goldilocks economy of not-too-hot and not-too-cold seems to be on the horizon. Fed rate hikes are likely on hold for the foreseeable future, even if trims aren’t forthcoming. Professional investors who are behind their benchmarks can load up on super-liquid mega-cap tech stocks with the comforting assurance that these stocks will be winners – creating a self-fulfilling prophecy.
Sure, next year will arrive in 24 trading days. But no one cares about that right now. Should they?
This post has been excerpted from a recent edition of Cabot Value Investor, to learn more about the undervalued stocks the market is missing, subscribe today.
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1. Bessembinder, Hendrik (Hank), Shareholder Wealth Enhancement, 1926 to 2022 (June 17, 2023). Available at SSRN: https://ssrn.com/abstract=4448099 or http://dx.doi.org/10.2139/ssrn.4448099
2. Bessembinder, Hendrik (Hank) and Chen, Te-Feng and Choi, Goeun and Wei, Kuo-Chiang (John), Long-Term Shareholder Returns: Evidence from 64,000 Global Stocks (March 6, 2023). Financial Analysts Journal, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3710251 or http://dx.doi.org/10.2139/ssrn.3710251
