A Case of Bad Breadth

January 10, 2024

This chart description is for illustrative purposes only and its accuracy cannot be guaranteed. Please see full disclosures at end of PDF document in the web post. General description: Four-line chart comparing cumulative returns of equity indices vs. their equal weight counterpart. Chart subtitle: A comparison between performance of market capitalization and equal weight indices illustrates the outsized impact of the “Magnificent Seven” on the U.S. equity market in 2023. Chart source: Bloomberg as of December 31, 2023. Chart visual description: Y-axis labeled “Cumulative Return” and ranges from -10% to +30%. X-axis labeled in monthly increments, from Dec-22 through Dec-23. MSCI EAFE Index line plotted in dark blue, MSCI EAFE Equal Weight Index in light blue, S&P 500 Index plotted in dark orange, S&P 500 Equal Weight Index plotted in light orange. Chart data description: Please contact us for the full dataset. Most recent data point, 12/29/23, as follows: S&P 500 at 26%, MSCI EAFE at 18%, MSCI EAFE Equal Weight at 16%, S&P 500 Equal Weight at 13%. End chart description. See disclosures at end of document.

The new year presents an opportunity for a fresh investment outlook. As investors hypothesize about where markets may be headed in 2024, a look back at performance during 2023 may prove beneficial. To that point, one of the major narratives over the last year was the dominance of U.S. equities relative to many other asset classes, as the S&P 500 Index returned approximately 26.3% in 2023. As many readers are no doubt aware, the “Magnificent Seven” companies (Amazon, Apple, Alphabet, Meta, Microsoft, Nvidia, and Tesla), which represent nearly one-third of the index, accounted for roughly two-thirds of the calendar year return for the benchmark. While the S&P 500 Index is often considered a proxy for the overall U.S. stock market, it is worthwhile to investigate the extent to which the 2023 return of the benchmark is indicative of broader strength across the equity spectrum, given the fact that just a handful of companies drove the majority of index performance. One way to do this is to assess the returns of equal weight indices and compare them to those of the more traditional, market capitalization weight benchmarks, since equal weight indices eliminate the outsized influence of mega-cap companies like the Magnificent Seven.

For the full calendar year of 2023, the S&P 500 Equal Weight Index returned approximately 13.9%, significantly underperforming its market capitalization weight peer. The S&P 500 Equal Weighted Index also underperformed its international counterpart, the MSCI EAFE Equal Weight Index (+16.9%), meaning the average developed large-cap international stock outperformed the average domestic large-cap stock last year. This comparison suggests that, due to greater breadth of returns, international equity exposure may serve as an attractive complement to domestic stock exposure at the overall portfolio level, given the performance concentration currently exhibited by the U.S. equity market. It is also important to remember that the S&P 500 Equal Weight Index has outgained the S&P 500 Index in 6 of the last 12 calendar years, as these figures speak to the mean-reverting nature of performance over time. Dynamics related to performance breadth and concentration will be important to watch in the year ahead, especially as investors monitor how companies such as the Magnificent Seven navigate the prevailing environment of higher interest rates and slower global growth. Above all else, both recent and longer-term market trends underscore the importance of portfolio diversification, as investors seek to reap potential future benefits of the mega-cap exposure, while also accounting for the risks of index concentration and the opportunities that exist elsewhere.

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