August 31, 2010
I want to talk about some of the sectors in the S&P, where they've been in the past, and where they are today.
Let’s start with the financial sector. What's the average importance over time for the financial sector in the US stock market?
The average importance has probably grown over the long term over the last three or four decades. Currently it's in the high teens. At its peak it was probably 20 to 25%, in roughly 2007. Clearly it came down very sharply with the financial crisis, as a huge number of large banks cut their dividends and a couple of very large public companies literally disappeared.
But what surprises many people is that the past decade, from the market bottom in 2002 to the peak in 2007, while financials are very important, they weren't incredibly dominant. It was not a financial repeat of the Tech boom. It was a broad-based improvement in the market over those five or six years.
Talking about the Tech boom, where did the Tech sector peak in terms of its importance in the US stock market?
The Tech sector was almost a once in history event. If you go back to about 1994 when it started, technology was around 8% of the Index. At its peak it was probably a third, 30 to 35% of the Index.
Today it's down to 15 or 16%. It's been moving up lately, and doing somewhat better. Probably in the long-term it will have a strong position. I'm not sure it will get back to the one-third level though.
One of the debates when it comes to investing is value versus growth. Those tend to be the two alternative approaches. What does your track record show in terms of the investor experience using a value approach versus a growth approach over the long term?
Over the long term, value tends to outperform, not year-by-year by any means, but over the long sweep of time. Value builds and maintains what appears to be a sustainable lead on a totally long-term basis. Value stocks tend to have higher dividends and are more likely to have dividends than growth stocks, and that's a big part of their long-term benefit.
But really the only time that growth seemed to suddenly surge ahead briefly was at the very end of the 1990s. At the peak of the technology boom, growth stocks were heavily dominating technology and appeared to be unstoppable. We know as a result of what happened shortly after the beginning of 2000, they were stoppable.
You mentioned dividends just a moment ago. Can you point to long-term data in terms of the investor experience focusing on companies that pay dividends compared to those that don't?
Yes. We put together a list a number of years ago which we continue to maintain, and what we nicknamed Dividend Aristocrats. These are companies in the S&P 500 with a record of at least 25 years of increasing their cash payout to investors.
So not only were they paying dividends or maintaining their dividends year-by-year, they were actually increasing their payout. There are not too many of them, and we've lost a lot in the last few years to other issues, but over the long term on a total-return basis, these stocks do very nicely.
Last fall I had a chance to interview Jeremy Siegel at Wharton. In his most recent book, Why the Tried and the True Beats the Bold and the New, one of his suggestions was that new companies get added to the Index after they've had the best period of their run-up, and investors actually are often not served by buying companies after they are added to the Index. What is your perspective on that?
Two things stand out, one particularly regarding Jeremy Siegel and his research.
He did some work a few years back for which we provided a lot of the background data, looking at the companies that were in the S&P 500 in March of 1957. This was when the Index moved from being 90 stocks, as it had been in ancient days, to being 500 stocks as it is now.
He studied how those companies did. His argument was that the original 500 actually outperform some of the ones that went in and out of the Index. There were a lot of particular stories in that period of time. So I'm not sure it's a general result, but it was a fascinating piece of work.
More to the focus of investors today, the S&P 500 is the large-cap stocks at the top of the market. Below that in size is a mid-cap Index of 400 stocks, and below that is a small-cap Index of 600 stocks.
The small-caps tend to be very exciting. There are some wonderful stocks there. There are some less wonderful stocks. They’re a little more volatile, and because they are small they are a little bit riskier typically.
The 500, as Jeremy Siegel suggests, are solid long-term good ideas, but they may have passed some of their high-speed growth.
Sitting in the middle turns out to be the mid-cap Index, and while obviously the past is no indication of the future, over the long haul since the mid-cap Index was created in the early 1990s, it does seem to have this attractive balance between the more rapid growing, more exciting, more dynamic smaller stocks, and the more secure larger stocks. It seems to get the best of both worlds.
For an investor who listens to Professor Siegel and doesn't want to own just the biggest stocks there are, but wants a little more interest and excitement, I would poke around and look at the mid-cap 400 among other things.
That sounds like an interesting idea, and one I think that many people hadn't thought of.
Is there a risk that of that the 400 mid-cap companies you'll get the 20 or so that excel, that really become home runs, and then they grow to the point that they move off the mid-cap Index onto the 500? So will investors lose the growth once they've met that threshold and are no longer in the mid-cap Index?
Looking at the three indices, a large proportion of the stocks going to the S&P 500 come out of the mid-cap.
The way we maintain the indices, a stock can only be in one Index of the three at a time. It can't be in multiple indices. A company that outperforms or grows faster than most other companies will move up in size, and if it continues to do so, it will move to the top of the mid-cap and it will become a reasonably good candidate to be moved to the 500.
There's certainly no guarantee. Number one in the mid-cap by size is no more likely than number five, or number 10, or number 15, to be moved into the 500, although clearly the top 50 to 100 are probably more likely than the bottom hundred.
The one aspect that makes it very intriguing is the following.
I mentioned earlier that a stock going in the S&P 500 gets a short-term bump up. So let's say we announced tonight at 5:15 that a stock is going to come out of the mid-cap and go into the 500 after the market closes a week from today, which is the typical time frame.
For this week, which is when it gets a lot of that bump, it is in the mid-cap Index. It is not in the 500. At the end of this week it will get moved into the 500. So if you were sitting on the mid-cap, you got the bump. It goes into the 500, and over the next two, three, or six months it gradually drifts down and gives back what we're calling an “artificial bump.” It's already in the S&P 500, which is another reason why the mid-cap might be an interesting thing to take a look at.
Display article as PDF for printing.
Would you like to send this article to a friend?
Remember, if you have a question or comment, send it to .
