Nobody wants to say this but I will.
The technology sector has gotten so big, so pervasive and powerful, that the stock market index creators had to break it up. Because the monopolist powers of these corporations off of the stock market and in the real world have not been checked by natural competitive forces or government intervention.
The big names in tech get bigger and bigger every year, their influence extending into all facets of modern life, no industry left untouched by the effects of this.
This has been reflected in S&P 500 in terms of market capitalization and the weighting these companies have. They’re almost a quarter of the large cap indices now. And even within the sector, a handful of enormous companies dominate. It’s like how the .01% of rich people have most of the wealth of the 1% in the world. The same thing is being mirrored across the corporate landscape.
This is actually something that the CAPEsters missed about stock market valuation – that we could one day have companies with moats so unassailable that classical valuation theory would cease to matter and comparisons to prior eras would be utterly inapplicable. Imagine telling investors in the 1980’s that someday Apple would be the world’s largest mobile phone seller and that they would earn 95% of the entire industry’s total profitability each year. How do you value that? How do you compare it to an index full of steel producers in the 1970’s ripping each others eyeballs out for every penny per tonne?
And the situation is getting more cartoonish, not less so.
As there appears to be no sign that something is going to happen in the real world to restore any sort of balance to the force, MSCI and S&P Dow Jones Indices (collectively, these two companies comprise the Global Industry Classification Standard or GICS committee) have taken it upon themselves to act. They’re going to spread things out in terms of industry group classification and re-weight the sectors. They’re reclassifying some technology companies as “communications” companies and changing an entire sector’s name from Telecommunications to Communication Services.
Information Technology stocks, as of the latest reading, had become 24% of the S&P 500 by the end of 2017. They were just 15% in 2006 and close to 10% at the end of 2000. Something had to be done, I suppose, before the IT sector became 27%, 30% and so on. The index constructors will say that Communications Services more accurately represents what a social media giant like Facebook actually does, but I think there’s more to it than that. You cannot have one sector be 2% of the index (telecom) and another be 24% and say it’s some sort of representative average of the economy.
And if the economy won’t cooperate with these aims, then the index has to change.
I’m going to give you all the details of the coming changes, straight from the horse’s mouth, but first a few takeaways:
- Sector rotation strategies have always been hilarious to me, but now they’re straight up abstract art projects. Take all your backtests and throw them out.
- There truly is no such thing as pure passive investing, just degrees of passivity. Indices, we ought to remind ourselves, are human constructs. They were not handed down from atop Mount Sinai nor are they naturally occurring phenomena. They’re lists of stocks and amounts cobbled together by a very human committee and, as such, should not be worshipped as the end-all, be-all of investment allocations.
- There are still plenty of quirks in the indexes left over to be scrutinized and poked fun at. For example, why is Walmart a Consumer Staple and Target a Consumer Discretionary – don’t we buy the same stuff from both, pretty much? And we’ll leave aside the more meta questions, such as if every company uses information technology as a core internal part of delivering their service or product, then what makes them not information technology companies? We’ll save that for a 2am dorm room discussion over a smoking bowl of Kalifornia Kush.
Okay, the official press release from the Cabal: