The S&P 500 is an index of 500 large U.S. stocks weighted by their market capitalization or market value. We know it today as one of the most important gauges of U.S. stock performance, covering a broad swath of 11 sectors. But when the index started in 1957 in its current form, its composition was vastly different. The original S&P 500 consisted of 425 industrials, 60 utilities, and 15 railroads.
The index always has reflected the state of the economy, and in 1957, the economy was built on industrials. It wasn’t until the mid-1970s that financials were introduced. By 1976, the index consisted of 400 industrials, 40 utilities, 40 financials and 20 transports, which included not just railroads, but also airline and freight companies. By 1988, the strict 400-40-40-20 format had to be abandoned because it became too difficult to find 400 industrial companies.
Over time, sectors within the index have swelled and contracted as their prominence in the economy has waxed and waned. In the early 1970s after the oil embargo, energy stocks prevailed. In the late 1990s dot-com era, technology did. And in the mid-2000s in the run up to the Great Recession of 2008 – 09, it was financials.
Today when we look at the S&P 500, there are a couple of things that stand out. First, technology dominates again, making up almost a quarter of the entire index. It’s not the same kind of tech dominance as we saw in the late 1990s with the ascendance of Cisco and Intel. Instead, it’s the dominance of consumer-facing tech companies like Apple, Facebook and Amazon (though Amazon actually is classified as a “consumer discretionary” company). That isn’t surprising given how we live. We swipe our credit cards at self-pay kiosks, buy much of our stuff with a click of a button, and use our smartphones to find highly rated restaurants and avoid traffic.
Second, it’s hard not to notice the famous FAAMA phenomenon – or the outsized effect of Facebook, Apple, Amazon, Microsoft, and Alphabet, the parent of Google. These super platforms make up a weighty 12% of the index, which means that to a great extent, as their fortunes go, so goes the index.
And third, it’s not just FAAMA that throws its weight around, but the biggest stocks overall. Mark Hulbert has called today’s environment a “winner-take-all” economy, where relatively few companies dominate. He’s cited a study by Kathleen Kahle and Rene Stulz showing that the percentage of total income earned by the largest 100 publicly traded companies has grown from 53% in 1975 to 84% in 2015. That is significant dominance. It also means that outside of the 100 largest companies, most companies are earning only relatively small amounts or actually losing money.
One reason the big keep getting bigger is network effects. That is when the value of a company’s services for each user rises as more users join. For example, as more people buy Apple phones, more apps get developed. And as more people join Facebook, the platform becomes more valuable. Some have argued that these network effects are so powerful that some technology companies deserve permanently higher multiples -- but we’d be very cautious about that idea. High multiples can last a very long time, but few things in markets really are permanent.
Still, there are implications for investors stemming from these bigger, more powerful companies. Much already has been written about how hard it can be to perform relative to the index if you don’t own the big five FAAMA (or the “fearful five,” as they’ve sometimes been called). But the other thing is heightened volatility. A bad day for Facebook or Amazon really can become a bad day for everyone. And if a giant should make a major misstep, a reversal of the network effect could be quite painful indeed.