The Blueprint

The FAAMG Effect

Aug 2020

The Market is Missing Breadth

Many of the conversations in the media about the stock market revolve around Apple, Amazon, Google, Microsoft and Facebook. It makes sense that these stocks are a common point of discussion; they are very widely owned, have performed exceptionally well, and even have their own acronym — the “FAAMG” stocks. With valuations rising to extraordinarily high levels many market analysts have focused on explaining why the FAAMG stocks are much better companies than the top tech names during the “tech bubble,” where valuations reached similar levels. These companies are showing that they are resilient, especially when it comes to recent performance despite the economic pressures created by COVID-19. Despite this strength, there are some risks that this outsized performance brings about that investors may not realize.

What is a Market Cap Weighted Index?

A market cap weighted index is a stock market index where the stocks are weighted according to their size as measured by their total market capitalization. This means that as large companies outperform smaller ones their weight in the index grows. This effect can be seen today where the 5 FAAMG stocks now make up 18% of the S&P 500 index — a market cap weighted index of 500 stocks.1 There has not been such a concentration in the top names since the “tech bubble” of 2000/2001.

FAAMG Stocks Make Up the Majority of the Market’s Return

Source: Source: Ycharts 1/1/2020-9/3/2020
FAAMG Index is defined as an equal weighted index of what are known as the FAAMG stocks (Facebook, Amazon, Apple, Microsoft, Google). Past performance is not indicative of future returns.

The chart above illustrates just how much disparity there has been between the big winners and the rest of the index. According to Barron’s, “market breadth is often used to assess the overall health of the stock market and forecast its future direction.” Historically, the greater number of stocks participating in the market’s positive movements has been an indication of overall economic strength. When the market’s gains are led by a small number of stocks, it can create concentration and diversification risk. Recent performance has certainly been led by a smaller number of names. This represents “narrow breadth” versus the healthier “wide breadth” observed when most stocks are doing well.

We are in an extremely challenging economic environment. The U.S. economy is facing the impact of a pandemic, bringing about massive unemployment, with stores and businesses closing in record numbers. While the market has been digesting these challenges, these companies have undeniably benefitted, while other companies have been unfortunately harmed. Although we appreciate the value creation these stocks represent, we also feel there needs to be a broadening of participation in this rally in order to create a healthier balance in the markets.

With so few stocks making up the market’s return, and with economic pressures mounting, investors that own market cap weighted index funds are at greater risk than they may realize. As these FAAMG stocks become a larger part of the index, the disparity in returns creates a concentration risk is created that people should be aware of when evaluating their investments.

Blue Square Wealth

At Blue Square rather than trying to predict the future, we aim to prepare for it, regardless of its direction. Using our proprietary technology and rules-based approach to investing, our decisions are not swayed by predictions or emotions.

Our investment strategy has a risk management focus that aims to position portfolios defensively during significant market declines. By systematically raising cash during these periods and then investing it when markets are more accommodating, we aim to create a less volatile investment experience, and ultimately deliver better risk-adjusted returns over full market cycles.

1) Source: as of 9/4/2020

Blue Square Wealth is a SEC-Registered Investment Adviser. A copy of the Firm’s Current Disclosure Brochures can be found on the SEC’s IAPD site or may be requested at any time by contacting us. Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Securities and Exchange Commission.

All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio. Past performance is not indicative of future returns.

Significant risk may accompany investments in stocks, bonds or other asset classes over short periods of time. Investment return and principal value will fluctuate with changes in market conditions. Your investment may be worth more or less than your original cost. Past performance is not indicative of future results.

This blog is a publication of Blue Square Wealth. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of subjects discussed. All expressions of opinion reflect judgment of author as of date of publication and are subject to change. Information contained herein does not involve rendering of investment advice. A professional adviser should be consulted before implementing any of strategies presented. Information is not an offer to buy or sell, or a solicitation of any offer to buy or sell securities mentioned herein. Different types of investments involve varying degrees of risk. Economic factors, market conditions, and investment strategies will affect performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. This document may contain forward-looking statements relating to objectives, opportunities, and future performance of U.S. markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “should,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to economic conditions, changing levels of competition in industries and markets, changes in interest rates, and other economic, governmental, regulatory and other factors affecting a portfolio’s operations that could cause results to differ materially from projected results. Such statements are forward-looking in nature and involve known and unknown risks, uncertainties and factors, actual results may differ materially from those reflected in forward-looking statements. Investors cautioned not to place undue reliance on forward-looking statements / examples. None of Blue Square Wealth or any affiliates, principals nor any other individual / entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances.