March 2024

To Our Business Partners


We have often talked about the problem of concentration in market indexes.  Price levels of the popular U.S. stock indexes have been led by just a few stocks with enormous market values, while the rest of the companies languish.  It’s not just a U.S. problem, either.  We learned that international markets have also experienced top-heavy results, perhaps more so.  For example, over the last 12 months, only 11 stocks (2%!) have accounted for fully half the gains in the major European market index of 600 companies. These top 11 have mirrored the performance of the “Magnificent Seven (Apple, Amazon, Google, Meta, Microsoft, Nvdia and Tesla)” here in the US over the last three years.  This cannot be sustained over the long-term. 
Why should we care about this?  Stock markets concentrated in a handful of mega-cap stocks have not fared too well in subsequent years.  The two most notable periods are the 1973-74 market after the “Nifity-Fifty” era and 2000-02 period during the internet bubble, both of which were plagued by significant concentration issues.  Today, with the ten largest companies accounting for nearly one-third of the popular S&P 500 index, combined with a similar situation worldwide, to your writers, the caution flags go up and the alarm bells sound.  The doesn’t mean the markets will crash tomorrow, but it’s an historically significant situation that worries us about considerable downside risk, the timing and extent of which is unknowable. 
It should come as no surprise that market partcipants would have similar behavior patterns no matter where they are located.  Among other reasons for this phenomenon, two stand out.  One is the popularity of indexing, a computer-generated means of automatically investing more money into the larger companies, creating a positive feedback loop.  The money that flows into an index fund is allocated to the top companies, making them even a larger component of the index, leading to an even larger concentration of the few. 
Second is career risk to many money managers whose performance is measured against the indexes.  These managers weight their portfolios close to the index weights to ensure their performance “hugs” the index.  If the manager underperforms, he runs the risk of losing his job because, of course, one doesn’t want to stray too far from the herd.  John Maynard Keynes famously said, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” (Your writers fall squarely in the “unconventional” camp!) 


Our group* of widely held stocks is priced at 92% of our estimate(s) of underlying value.  What this means is that, if the group was purchased today and reached full value – 100% — over a 5-year period, the annualized return (before any cash dividends) would, unfortunately, be less than 2%Why do we want lower stock prices and/or new stocks to buyBecause your future returns would get betterIn other words, if the group of stocks sold at, say, our two-thirds-of-value benchmark, your estimated 5-year annualized return would jump considerably to over 8%The LOWER the starting valuation, the BETTER the returnsThat’s the arithmetic of VALUE INVESTINGacquiring profitable, financially sound, growing, well-managed companies at bargain prices.


Stock market indexes produced positive returns across the board in February, ranging from 2-6%The larger gains again were in the big cap indexes, except for the Dow Jones Industrials bringing up the rear at just over 2%The major market indexes continue to be driven by a narrow group of stocks (see commentary above). Over the last twelve months the large cap indexes continued to dominate, advancing 2040%, while the smaller cap indexes experienced gains of 4-10%. As another notable example of this concentration phenomenon, the equal weight S&P 500 has advanced about 11% over the last 12 months, while the capitalization-weighted index has advanced 28%. Only a handful of stocks are driving the market. Our group* of portfolio stocks compares favorably to most of the indexes over the periods discussed. 

Steve Nichols, CFA • Bill Warnke, CFA •  Andy Ramer, CFA

*The group of “portfolio stocks” — our Equity Composite for the purpose of evaluating investment performance — consists of 19 stocks that are held in our clients’ accounts. Portfolios might hold some or all of these stocks, depending on investment guidelines unique to each client, the timing of purchases and sales, and start dates of accounts. The performance of this group of stocks is a good proxy for our equity performance but might vary widely among accounts. Of course, past performance is not necessarily indicative of future results.

We hereby offer to deliver to you without charge a copy of our current Form ADV Part 2, in accordance with the U.S. Securities and Exchange Commission’s “Brochure Rule.” Please contact us if you would like us to send you a copy.