The market and sector concentration

17 feb. 2020

Dear Investor,

On the back of the United States and China signing phase one of the trade deal investors started the new year in an optimistic mood and, during the first half of the month, the global equity market recorded gains of about 4%. Yet, concerns over the coronavirus quickly shifted investor’s sentiment and in little over a week most of the initial gains of 2020 were taken back. In the end, the MSCI ACWI ended the month with a 0.2% gain in Euro-terms.  There was a clear flight to safety as we saw the USD appreciate against most other currencies, government bonds outperform the equity market, and the oil prices plummet during the month. Within the equity markets, strategies such as Momentum, Growth and Low Volatility beat Value and Small Cap stocks by a landslide. Regionally speaking Emerging Markets (-3.4%) clearly bore the brunt of the blow as their growth prospects are most likely to be impacted by the coronavirus. Yet, Europe (-1.3%) also performed significantly worse than the United States (+1.5%). 

The US are of course helped by the prevalence of technology companies, which had another stellar month. When you correct for the GICS reclassification of September 2018 - where about 5% of the IT sector was transferred to the communication services sector, high-tech currently has a weight of about 30% in the S&P500. This rivals the weight the sector had at the precipice of the dotcom bubble and should help remind investors of the dangers of concentration risk. After all, the rise and fall of industries isn’t new... From IT stocks in 2000, to Financials in 2007 and Energy companies in 2008, a quick increase in weight or a large absolute weight have all turned out to be mean-reverting in the end.

While we don’t want to predict the next dotcom bubble or the downfall of the FAANGs, who have driven so much of the index’ return over the past years, we just want to make investors aware that owning the market inherently comes with this concentration risk. Evidently, active investors have more opportunities to deviate from this benchmark, which makes it hard to compete with the benchmark when the biggest sectors keep on expanding, but should limit drawdowns when the music eventually stops.

Kind regards,

Werner, Thierry & Nils