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Strategic Insights

Volume 12, Edition 17 | June 5 - June 9, 2023

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Concentrating on Risk

Doug_Walters Doug Walters | Articles

Read Time: 2:00 Min


The strong performance of the US stock market masks a risk lurking under the surface that investors need to keep in mind. Luckily, there is an easy fix.

Contributed by Doug Walters , Max Berkovich , David Lemire , Eh Ka Paw

On the face, it has been a great start to the year for equities. US large-cap stocks are up double digits. But market leadership is narrow, and once again, we see concentration risk for those with traditional market cap-weighted exposure to the market.

The S&P 500 produced a total return of over 12% to start the year. But this attractive return masks a hidden risk under the surface – concentration risk. It seems odd to mention concentration risk in an index of hundreds of stocks. Yet here we are. There was a time when a broad index like the S&P 500 lacked individual stock risk. But the birth of mega-cap technology stocks has changed everything.

Six companies, Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG, GOOGL), Amazon (AMZN), NVIDIA (NVDA), and Tesla (TSLA), represent over 25% of the weight of the index and over 75% of this year’s returns. Without those six companies, the index’s total return would have only been 2.9%.

Will these mega-cap growth stocks continue to lead the way or repeat their 2022 collapse? Only time will tell. We do not try to predict the unpredictable. However, we can tell you that along with the concentration risk, the valuations of these stocks are well above average. If you own them, now may be a good time to diversify your large-cap US exposure.

How can you better diversify? We prefer market exposure that is fundamentally weighted, not market cap weighted. Our preference is multifactor funds which weight exposure based on attractive value, high quality, strong momentum, and small size. But even a simple equal-weighted index could do the trick. Not only will these funds reduce your concentration risk, but they have also historically outperformed.


weighting in just six companies

The S&P 500 is up over 12% this year, but 75% of that return comes from just six companies representing over 25% of the index.

Headline of the Week

China Wobbles, Europe Falls Down

There has been a steady drip of news highlighting issues with China’s post-Covid emergence. With their rather sudden abandonment of zero-Covid restrictions, the expectation was a global tsunami of economic activity coupling China’s traditional strengths as the world’s manufacturer with an eager-to-spend populace. The initial surge primarily has played out, and there are growing concerns around several structural issues with China’s economy. Namely, there are issues with property markets, local debt burdens, and, more concerning massive youth unemployment. Global growth may not be able to rely on China as it did post the Financial Crisis.

Elsewhere, Europe “technically” is in a recession as Germany falters. Germany is the main engine for the EU, but Ireland tipped the balance. However, unlike China, Europe’s issues appear more transitory. The ECB does not seem too concerned, as they gave no sign of pausing their interest rate increases. Inflation is slowly moving down and is still significantly above its targets.

For now, these global growth issues remain overseas. The US remains cautious of recession risks but continues to surprise positively. Next week’s inflation data and Fed meeting (see below) should provide hints as to which way we are headed.

The Week Ahead

It is a marquee week for the market with a big inflation report right as the Federal Open Market Committee assembles for a rate decision. The European Central Bank and Bank of Japan are also on the clock.

Interested Parties

Tuesday’s Consumer Price Index (CPI) for May will provide what could be the scale tipper for the Central Bank.

  • A year ago, the CPI peaked at 9.1%. So, whatever the number is, we are in a better place.
  • Estimates are that the headline number will dip to 4.1%, but the core, which excludes food and energy, will remain above 5%.
  • Deviation from the estimates will cause gyrations in the market.

Stop, Skip, Or Go Once More?

The Federal Reserve will enter its two-day meeting with what seem to be three options: hike rates for the 11th time, declare the job is done and stop hiking, or take a break.

  • While the 2nd option isn’t realistic, the Central Bank will not commit to an end of hikes as it needs to respond to market conditions, and inflation is still way above trend.
  • A pause is likely as the last weekly jobs report started showing a few cracks.
  • Another quarter percent hike is still on the table, and commentary from voting members shows the committee is divided on this one.
  • Going into the weekend, markets are pricing a 33% chance of another hike, which could swing significantly after the inflation report.
  • Investors will also pay strict attention to the new dot plots, which chart the current expected rate direction by the people with the biggest say.

Next at Bat

The European Central Bank (ECB) and Bank of Japan (BOJ) face rate decisions after the Federal Reserve is done.

  • The ECB is expected to lift rates a quarter of a percent on Thursday to 3.5%, not quite the 5% we have in the States.
  • With Germany in a recession and inflation coming down, there may be some pressure to take a break. But the Eurozone Flash CPI in May was still above 6%.
  • Japan, unlike the other major economies, is not hiking rates. It faces a different problem.
  • Japan has an accommodative monetary policy, a negative 10-year interest rate, and relatively low inflation.
  • Will the new Governor Ueda start changing the narrative on the yield curve controls?

Supersize Me!

The forced merger of Switzerland’s Credit Suisse and UBS is expected to be completed next week.

  • The merged bank will have a $1.6 Trillion balance sheet and oversee $5 Trillion of assets.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets of over $2 billion.