In the early 2020s, the stock market looked much like basketball used to: a big man’s game. As examples, money management firms like Vanguard and Blackrock lumbered to higher heights of assets while the passive firms swallowed more market share. This big-man game flowed through to the constituents represented in the passive bucket. Today, Apple and Microsoft are 14% of the S&P 500 and the top five holdings represent 26% of the index.
These large players in the money management business and the stock market are reminiscent of basketball prior to 1980. In the prior era, the famed big men were Bob Pettit, George Mikan, Wilt Chamberlain, Bill Russell and Kareem Abdul Jabbar. However, this did not hold as the NBA temporarily introduced the three-point line in the 1979-1980 season, only to never let it go.
The value of the three-point line is determined by the person shooting. If a shooter can make 50% of their two-point shots, they make one point per shot. This is the efficiency of their scoring. To be as efficient from three-point land, they would only need to make 33.3% of their shots because you get 50% more points. In other words, it’s a riskier shot that may compensate you for that risk. When the three-point rule was first adopted, teams didn’t naturally figure out how powerful it could be or train shooters for it. For young, strong shooters like Magic Johnson and Larry Bird, it was perfect timing.
In many respects, there is a three-point line that has arisen in the stock market, whether investors or money management firms recognize it. The higher percentage, two-point shots have come in the form of owning the S&P 500 Index or blue-chip quality American companies. However, the investors shooting these highly successful shots haven’t won in the stock market recently, particularly over the last 15 months. Instead, it has been more cyclical, capital-intensive businesses, or as we think about it, higher risk, like the three-point line. Energy companies, commodity-oriented businesses and other lesser-known industries have been putting the most points up on the board.