Outperformance of the S&P 500 vs the equal weighted S&P 500
* Positive/negative values indicate outperformance/underperformance of S&P 500 (market cap weighted) over its equally weighted index
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 7/19/23
Our Chart of the Week illustrates this phenomenon by comparing the performance of the (market value-weighted) S&P 500 with that of the equal weighted S&P 500, in which each stock is given an equal weighting, regardless of its capitalization. Here you can see how stark the difference has been this year – as high as it last was in the late 1990s, the heyday of the dot-com bubble. If there are several of such years in a row (2017-2019) or if the difference is as marked as it has been so far this year, the heavyweights increasingly dominate the index. For those who have a problem with this and do not quite trust the flight to the top, consider the equal weighted S&P 500 as a benchmark, especially if the investor does not want to try to time the market but, rather, tends to buy and hold. With the equal weighted index, it would allow technology stock in a portfolio – which, we believe, is essential in the long run, as the tech sector has the potential to remain a growth engine, not least because of the artificial intelligence wave. But in the short term we are skeptical about these stocks as we believe their share price performance has run ahead of their earnings and of our earnings expectations for the sector.
From our perspective, this year's rally appears to be based solely on expansion of the sector's price-earnings multiples, not on any increase in profits. And there will likely be little increase in profits this year. We doubt whether the current record valuations (for example, for growth stocks against blue chips) will survive the coming months unscathed if the U.S. slides into a recession or interest rates stay higher for longer than expected. We also do not see it as a good sign when stock market investors are correcting the overweighting of a handful of companies in an index by themselves, by switching to equal weighted alternatives. We believe it is the antitrust authorities who ought to be intervening to correct the index’s weighting.