June Charts of Interest: High Concentration Is Covering Market Undercurrents

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Many of you have seen me point out the S&P 500 index’s high level of concentration over the past several months. Well, it continues to get even higher.

“When it comes to measures of the market, May’s elephant in the room is concentration,” says S&P Dow Jones Indices. Currently, the combined weight of the top 10 largest constituents in the S&P 500 sums to 34%, the highest in multiple decades.

To put this number into perspective, S&P Dow Jones Indices defines the top quartile of concentration as 22.9% or higher.

Source: S&P Dow Jones Indices.

Time to Look at Buybacks and Dividends?

S&P Dow Jones Indices also looked at what happened after previous such occurrences. During the 12 months following the S&P 500’s concentration reaching or exceeding the 22.9% mark, strategies targeting companies that return profits to shareholders have fared well. Buyback strategies have realized the highest returns followed by high-dividend-yield and high-dividend-growth strategies.

Source: S&P Dow Jones Indices.

It Can Be Good to Be #2 or #3

While some Olympic athletes will disappoint about receiving silver or bronze medals next month, ranking number two or number three in the stock market can be a good thing. Michael Mauboussin and Dan Callahan, CFA, of Morgan Stanley found the second- and third-largest stocks at the end of a calendar year have historically gone on to outperform the largest stock.

The relationship between the top three has changed between 2013 and 2023. The largest stock has outperformed the second- and third-largest stocks, though all three have still outperformed. Mauboussin and Callahan believe the change largely reflects the relative returns of the main stocks that have shuffled through the top three spots, including Apple Inc. (AAPL), Microsoft Corp. (MSFT) and Alphabet Inc. (GOOGL).

The Elite Group of the Largest Stocks

Here is one additional chart from Mauboussin and Callahan. This one plots the largest stocks in the U.S. since 1950. Just 17 stocks are on the list. Of these 17 stocks, only 11 ranked within the top three for more than two years. Four have fleetingly been number one at some point during a given year but failed to hold the top position at the year’s conclusion.

Many Stocks Are Not Participating in the Rally

A metric strategists look at to gauge the underlying health of the market is the proportionate number of stocks trading at 52-week highs compared to those trading at 52-week lows. CNN factors this metric into its Fear & Greed index, from which I pulled this chart.

Though the market-capitalization-weighted S&P 500 is having a good June, many stocks are declining this month.

Source: CNN.

The Equal-Weighted S&P 500 Is Lagging the S&P 500

Here’s a different view of market breadth that I created on StockCharts.com. The S&P 500 Equal Weight index, represented here by the Invesco S&P 500 Equal Weight ETF (RSP), is lagging the market-cap-weighted S&P 500. Both hold the same stocks, but they weight them differently. The recent split demonstrates how just a few stocks are driving the headline market returns you see.

Source: StockCharts.com.

For Value, Look at Small-Cap Stocks

Only small-cap stocks are currently trading at or below historical valuations. BofA Global Research found that small-cap stocks are trading at a 7% discount based on current trailing price-earnings (P/E) ratios and close to average based on forward price-earnings ratios, price-to-book-value (P/B) ratios and enterprise-value-to-free-cash-flow ratios. Large-cap stocks are trading at substantial premiums across the board.

Source: BofA Global Research.

Analysts’ Buy and Sell Suggestions

Finally, here is what analysts think will outperform and underperform going into the third quarter. Keep in mind that analysts are loath to call a stock a sell. When they do, it is often after much of the bad news has already been priced in.

Of the 11,740 ratings FactSet compiled, 54.7% are buy ratings, 40.3% are hold ratings and 5.0% are sell ratings. Do your own analysis before following any buy or sell recommendations.