Consider how little these beaten-up sectors mentioned above affect the indexes. Department stores may have fallen 62.3%, but on a market-cap basis they are a mere 0.01% of the S&P 500. Airlines are larger, but not much: They weigh in at 0.18% of the index. The story is the same for travel services, hotel and motel REITs, and resorts and casinos.
The market is telling us that these industries just don’t matter very much to stock market performance. And the sectors that do matter? Consider just four industry groups—internet content, software infrastructure, consumer electronics and internet retailers—account for more than $8 trillion in market value, or almost a quarter of total U.S. stock market value of about $35 trillion. Take the 10 biggest technology companies in the S&P 500 and weight them equally, and they would be up more than 37% for the year. Do the same for the next 490 names in the index, and they are down about 7.7%. That shows just how much a few giants matter to the index.
On some level, it’s completely understandable why many people believe that markets are no longer tethered to reality because the performance doesn’t correspond to their personal experience, which is one of job loss, economic hardship and personal despair. But what’s important to understand is that indexes based on market-cap weighting can be—as they are now—driven by the gains of just a handful of companies.
We can argue about whether the way the market reacts is good or bad and never reach a satisfying conclusion. But one thing the market isn’t is irrational or disconnected from is the reality of market capitalization, and its impact on stock indexes.
This article was provided by Bloomberg.