After going half-insane watching a tiny cabal of technology megacaps rule stock indexes all year and make their benchmarks almost impossible to catch, active fund managers may be on the verge of liberation.
Positive vaccine news is fueling optimism that an economic reopening is no longer a pipe dream. That’s sparking a rotation into a much broader array of beaten-down companies, such as small-cap and value shares. With the S&P 500 no longer ruled by just five names, active investors may finally have found the kind of target-rich environment where their skills thrive.
“If you’re small enough and nimble enough, you can take advantage of these opportunities,” said Doug Ramsey, Leuthold Group’s chief investment officer. “The S&P 500 has been a very difficult bogey for the last four or five years.”
As everyone knows, the coronavirus pandemic and lockdown unleashed a seemingly endless bid for tech titans such as Facebook Inc., Amazon.com Inc., Apple Inc., Microsoft Corp. and Alphabet Inc. The group has surged nearly 67% since March’s lows, powering a 60% rebound for the S&P 500 in the process. As an illustration of how hard it has been to find alpha, at the height of the tech mania in August, just 30.6% of the stocks in the S&P 500 outperformed the index over the prior year — the lowest share since July 2000, according to data from Leuthold Group.
The rush into tech has inflated the group’s influence on the S&P 500. Coming into 2020, their combined weight stood at just under 17% of the index. That figure has swelled to 22% not even 11 months later.
Their grip might be loosening though. Breakthrough results on Nov. 9 from Pfizer Inc.’s and BioNTech SE’s Covid-19 vaccine trial boosted the Russell 1000 Value Index to its biggest weekly gain versus the Russell 1000 Growth Index since 2000. Tech, which dominates the growth gauge, stumbled the most. More good vaccine news from Moderna Inc. a week later added to the rotation and now the value index is on track for its third consecutive month of outperformance — the longest streak since late 2016.
Should that rotation take further root, managers who’ve been punished for not having big stakes in megacap tech might get a chance to catch up. Those who had less than 10% allocated to the cohort have gained 5.8% on average this year.Star managers reliant on their tech-heavy portfolio tilts may feel the pinch. Among some 200 equity funds benchmarked to the S&P 500 Index with at least $500 million in assets, those with at least one-fifth of their portfolio parked in Facebook, Amazon, Apple, Microsoft and Alphabet have returned 17.8% on average this year.
“For those active managers that have either not owned some of those leading names or have otherwise been underweight, it provides them an opportunity to play some catch up,” said Ben Johnson, Morningstar’s global director of ETF research. “Many in the market have been in part pinning their hopes on those leaders falling out of favor.”
Just 21% of large-cap core funds are beating their benchmarks this year, according to data from Jefferies Inc. They fared better in October, with 39% outperforming as the equal-weight version of the S&P 500 posted its strongest month against the market-cap index since 2011. The measure that treats Delta Air Lines the same as Apple is beating the cap-weighting index by 3 percentage points in November.
Of course, big tech’s demise is no sure bet. That much was clear on Thursday, when market focus turned to rising case counts and the economic impact of tougher restrictions. The Nasdaq 100 climbed 0.8%, outpacing gains in the S&P 500 and the small-cap Russell 2000.
Still, the mathematics favor stock pickers should the tech sector falter. Without the big five’s gain, the S&P 500’s 10% year-to-date climb dwindles to just 2.4% — a much easier hurdle to clear.
“To an extent, just mathematics is going to make it hard for a market cap-weighted index like the S&P or Russell to make ground if the largest piece of that market is struggling,” Kevin Caron, portfolio manager at Washington Crossing. “The market ahead is one that better suited for a stock picker than a buy-and-hold index fund investor.”
— With assistance by Claire Ballentine, and Vildana Hajric
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