A simplistic risk-on / risk-off understanding of markets does a remarkably good job of explaining why large-cap growth stocks go up and down as compared to the rest of the market.
I wonder if something like the CNN Fear/Greed indicator might be correlated if averaged in the long run.
I don't think that's true at all tbh.
The current concentration is unprecendented, and you would have had to have been very smart to be able to have predicted it say, 10 years ago - Historically when companies hae grown to dominant positions that eventually turns them into stalwarts that are then replaced in the next secular cycle. What's so unique about so the large caps today is how they all have huge a networking effect that increases their moat as they get larger, which is how they've managed to keep growing to these gigantic sizes and still keep growing. It could be argued that they've become very attractive to traditional "defensive" investors as this network-effect moats form give them huge defensive properties, and yet also still attractive to risk-seeking investors due to their growth.
Maybe a better way to frame the question is when do small caps outperform?
Historically this has been when
- towards the tail end of bull markets when risk appetite is greatest and people are looking for "the next xyz" multibagger
- when the monetary conditions are loosest, as smaller companies are often more constrained in their ability to access cheap finance
There are many other factors but tbh they are quite debatable - to me these are the main ones
Personally I don't worry at all about the concentration, and I would rather underweight US equities as a whole but keep my allocation cap weighted than be all-in on US but more tilted to EWing.
Excellent points. Big tech is uniquely suited to take advantage of the patent system, the Communications Decency Act, gateways based on apps and URLs, and the inherent scalability of internet-enabled services to create moats and drive up revenue-per-employee, so that they never have to become bloated and complacent.
And I agree, small caps should be expected to benefit from
looser financial conditions,
falling rates, and FOMO narratives like we're seeing today. Their growth is mostly limited by access to cheap funding, rather than demand itself.
These reasons may have motivated the OP's question. It certainly looks like things are lining up favorably for companies other than the biggest mega-caps. And at the same time, it looks like large-caps are dangerously overvalued, even if they do have advantages.
E.g. in January 2000, just before the dot-com meltdown, the S&P500 had a forward PE ratio around 25, and the S&P600 small cap index was at around 18. By 2004, both indices' PE ratios had converged on about 18. Today, the S&P500 is at a forward PE of 22, while the S&P600 has risen to 17.
Today's 5x gap is less than the 7x gap which preceded the 2000-2003 bear market, but not far behind. I don't know if it's safe to call it a "rule" that EW will outperform cap-weighting when large caps get too expensive compared to their peers. It may be safer to say all stocks are in danger when that happens.
To share another quote from an article shared below by
@markbike528CBX For example, while the cap-weighted S&P 500 declined 47% from peak to trough [after the 2000 tech bubble], the equal-weighted S&P 500 only declined 26%, a notable divergence.
The difference between EW's +21% outperformance after the 2000 tech bubble and EW's -4% underperformance after the 2008 crisis may be revealed in the valuation chart above. In 2000, concentration was high and the top-performers fell the hardest. In 2008, concentration was relatively low and everything fell. Of course, it's also worth mentioning that 2000-2002 happened because of valuations, whereas 2007-2009 was a liquidity crisis. Today's valuations look more like the pre-2000 world than the pre-2007 world, as can be seen above.
Essentially, the setup to the 2000-2002 bear market featured large caps being much more expensive than smaller stocks, whereas the setup to the 2007-2009 bear market features small caps being much more expensive than large caps. In both cases, the bear market reset valuations so that large and small caps had forward PE's close to one another, and significantly lower than before.
