Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

4th Quarter | 2023

Quarterly recap



Current market environment performance of dynamic, risk-managed investment solutions.

By Will Hubbard

The first quarter of 2023 reminded us that markets don’t always behave as expected.

Most indexes did well for the quarter, though to vastly different degrees: The Russell 2000 small-capitalization index was up 2.96%, emerging markets were up 3.24%, the S&P 500 was up 7.46%, and the tech-heavy NASDAQ was up an astounding 21.35%.

These returns might help investors feel better after last year’s decline, but what is driving them, are they sustainable, and what should investors do to prepare if the market suddenly takes a turn?

Are the S&P and NASDAQ indexes too concentrated?

First, let’s look at what’s behind this performance. The S&P 500 Index and the NASDAQ owed their good fortune to just a few large tech companies that are heavily weighted in both indexes—though to a lesser degree in the S&P 500. For instance, Apple makes up almost 12% of the NASDAQ and just 7% of the S&P 500.

Both indexes are market-cap weighted, meaning they weight their constituents based on the size of the company. For example, if a market-cap-weighted index was composed of two companies—one worth $2,000 based on market capitalization and another worth $1,000—then the total market cap would be $3,000. The first company would have a weight of 66.67% in the index, twice that of the second company.

The drawback of this approach is that your index can become overly concentrated in a small number of large stocks or a particular sector, jeopardizing diversification.

In the S&P 500, 41 companies cover 50% of the entire Index—meaning roughly 8% of the Index accounts for half of its performance. This is why it’s problematic when people cite the S&P 500 as a bellwether for the entire economy. It undervalues the importance of companies like General Motors and Ford—each of which accounts for 0.14% of the S&P 500 Index. The following chart shows what little effect small companies within the Index have on the Index overall.

This effect is even more pronounced in the NASDAQ 100 where 7% of companies account for 51% of the Index. If a company isn’t Microsoft (+20.5% Q1), Apple (+24.4% Q1), Amazon (+21% Q1), Nvidia (+87.8% Q1), Google (+20.3% Q1), Meta (+78% Q1), or Tesla (+48% Q1), does it even matter?

Putting numbers to the index constituents and their contribution to performance shows some of the flaws of a market-cap-weighted approach. It also highlights the risk of taking the NASDAQ’s 20% performance in the first quarter as a sign that the economy has recovered and is heading to new highs.

In the first quarter, a mid-March rally led by big tech caused the S&P 500, which had been up less than 1% at that time, to finish the quarter up 7%. About 6% of that came from just 11 companies. The rest of the companies in the Index had mixed performances and their contributions to returns were minimal.

The NASDAQ has a similar story: 12 companies accounted for over 15% of its 20% return in the first quarter. The rest were just … the rest.

Will the good times last? And what happens to your portfolio if they don’t?

First-quarter returns for this year were great—especially after a dismal 2022. I’m not trying to diminish that. I’m simply pointing out that there were some exceptional performers in a sea of less-than-stellar results.

Rather than sticking our heads in the sand, or saying “markets will recover,” now is the time to be exceptionally diligent. The last 15 months have been exhausting, and this will likely continue to be the case in the coming months. In moments like these, investors need to prepare to take advantage of the next opportunity—wherever that may come from. For example, commodities performed extraordinarily well the last two years, and developed European equities are off to a strong start in 2023.

What happens if the U.S. dollar’s current weakness continues? What if geopolitical tensions decline (or ramp up)? What if interest rates continue to rise? Are you prepared?

Preparation is recognizing the limitations of the U.S. market-cap indexes and considering alternatives such as baskets of equally weighted securities using strong historical fundamental factors, macroeconomic data, technical indications of change, and opportunities both foreign and domestic.

This is not the time to give in to the weariness the market may be provoking. It’s time to make sure your portfolios contain quantitative, actively managed investment strategies that respond to market changes and continuously manage for the risk and opportunity present in all market environments.

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