Inside ETFs 2020
February 3, 2020
By Exponential ETFs

In the years since the Global Financial Crisis we have seen incredible returns in the equity markets. It has been wonderful for investors, for many of us, and for our clients.

Of all the markets around the world, the US markets have done the best. As a result of home bias, the dominance of the US markets have given even more of a boost to our portfolios and our businesses.

And of all the stocks inside the US markets, none have done quite as well as the largest platform technology stocks.

Single stock market caps vs entire S&P 600

Source: Exponential ETFs | Data source: Bloomberg LP 1/16/1010

What Amazon has done over the past ten years is remarkable. From a small book-selling website to a company processing HALF of all online sales in the country. Amazon is up 15-fold over the past ten years.

What Apple has done, no less impressive. From “1000 songs in your pocket” to a super-computer in every pocket, more than a billion phones sold, and control over the operating system for just about everything we do.

Microsoft. Google. Facebook, it’s the same story. These are the companies that have won the past decade and that sit on top of the greatest stock market in the world.

Three stocks larger than mid cap + small cap

Source: Exponential ETFs | Data source: Bloomberg LP 1/16/1010

Just five companies now represent more than 18% of the entire US economy and almost 10% of the global economy by market capitalization. Any three of them alone have a higher market capitalization than the entire S&P 400 and S&P 600 combined.

But alas, no trade lasts forever. Companies do not grow forever. And we believe the momentum that has driven these stocks further and further up in the last couple years betrays the growth possibilities that had propelled them in the earlier years of the past decade.

Source: Exponential ETFs | Index constituent source: S&P Dow Jones Indexes. Market capitalization source: Bloomberg LP 1/16/2020

Historical HHI of SPX

Source: Exponential ETFs | Index constituent source: S&P Dow Jones Indexes. Market capitalization source: Bloomberg LP 1/16/2020 | HHI is a common measure of concentration and was calculated by Exponential ETFs

But NEVER with so much sector concentration

Source: Exponential ETFs | Index constituent source: S&P Dow Jones Indexes. Sector classification source: BloombergLP 1/16/2020

We have seen concentration like this before, but never, never in the history of the stock market, has such concentration of the top stocks been limited to a single sector, comprised of companies with similar risk characteristics. Risks of antitrust regulation. Risks of being unable to penetrate emerging and new markets. Risks of saturation. Risks of being disrupted, as all companies eventually come to be.

Runaway valuations at the top

Source: Exponential ETFs | Valuation data source: Bloomberg LP 1/16/2020

These companies now show fundamentals that simply do not support those valuations. Their current market capitalizations represent the awesome growth that they have had, but not the future growth on top of that, which these valuations would imply. The valuations only make sense by extrapolating INTO the future, growth that has already come to pass.

How has it worked out historically?

Data period: January 1, 1980 – December 30, 2019 | Sharpe ratios are calculated using a risk-free rate of 4.21% annually (avg of 13-week T-bill rate over the sample) | S&P index return data source: S&P Dow Jones. Stock performance data source: Bloomberg LP | All calculations performed by Exponential ETFs

We know how the largest companies have done in the past. We have studied it. We know that they have shown LOWER returns, with a HIGHER standard deviation, than owning the rest of the market.

40 year cumulative returns (1 yr holding)

Source: Exponential ETFs | Index constituent source: S&P Dow Jones Indexes. Stock data source: Bloomberg LP. Calculated by Exponential ETFs

But what I really want to do here today is to make you think. Make you think about how your capital is allocated. Make you think about which companies you have trusted to allocate that capital. Which ETFs you want to buy, and from which issuers.

40 year cumulative returns (2 yr holding)

Source: Exponential ETFs | Index constituent source: S&P Dow Jones Indexes. Stock data source: Bloomberg LP. Calculated by Exponential

40 year cumulative returns (5 yr holding)

Source: Exponential ETFs | Index constituent source: S&P Dow Jones Indexes. Stock data source: Bloomberg LP. Calculated by Exponential ETFs

Time to take mega-cap profit?

Source: Exponential ETFs | Index constituent source: S&P Dow Jones Indexes. Stock data source: Bloomberg LP. Calculated by Exponential ETFs

How can I manage the risk?

                 

Will you continue to only allocate to crowded funds and crowded factors from the biggest providers, in products that allocate to the biggest stocks? Or will you look to the future, not the past. To the NEXT Apple, the next Amazon, and yes, the NEXT Blackrock.

That is how you will get exposure to the next market cycle trend. And that is how we will continue to seed the entrepreneurial spirit that has blossomed into the greatest market in the world.

      

Wall Street’s most innovative funds

Made in Detroit

www.exponentialetfs.com

My name is Phil Bak. My company is Exponential ETFs. My solution to the concentration risk is the Reverse Cap Weighted U.S. Large Cap Index.

 

Disclosures:

The information provided is for educational, illustrative and discussion purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy or sell, any securities or investment products sponsored or sub-advised by Exponential ETFs. Investments in securities, derivatives, commodities, futures, options and other financial instruments are risky and may not be an appropriate investment. No guarantee or representation can be made that an investment will generate profits or that an investment will not incur a total loss of invested capital. Furthermore, nothing herein is intended to imply that any investment strategies may be considered “conservative”, “safe”, “risk free” or “risk averse.”

Certain information contained herein has been obtained or derived from unaffiliated third-party sources believed by Exponential ETFs to be reliable. Neither Exponential ETFs nor any of its affiliates or representatives makes any representation or warranty, express or implied, as to the accuracy or completeness of the information contained herein.

Any issuers or companies mentioned herein are for illustration and discussion purposes only and are not intended to be an endorsement or condemnation thereof.

The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. It is not possible to invest directly in an unmanaged index.

The S&P MidCap 400 Index, more commonly known as the S&P 400, is a stock market index from S&P Dow Jones Indices. The index serves as a barometer for the U.S. mid-cap equities sector and is the most widely followed mid-cap index. To be included in the index, a stock must have a total market capitalization that ranges from $1.6 billion to $6.8 billion at the time of addition to the index. It is not possible to invest directly in an unmanaged index.

The S&P SmallCap 600 Index is a stock market index established by Standard & Poor’s. It covers roughly the small-cap range of US stocks, using a capitalization-weighted index. To be included in the index, a stock must have a total market capitalization that ranges from $450 million to $2.1 billion at the time of addition to the index. It is not possible to invest directly in an unmanaged index.

The Herfindahl Hirschman Index (HHI) is a measurement used to understand the level of competition that exists within a market or industry, as well as give an indication of how the distribution of market share occurs across the companies included in the index.

 

 

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