Key Investment Themes of the Last Decade

By Steven Fraley

The global stock market has provided an abundance of fascinating cocktail party conversations over the last decade. Market returns have been driven by several key themes, many of which have bucked historical trends.

At the top of the list of themes has been the growth and concentration in the S&P 500 Index of five mega-cap technology stocks: Facebook, Amazon, Apple, Microsoft, and Google. These stocks have outperformed the broader equity market, spurred by consumers escalating their e-commerce retail spending, as well as spending more time on their computers and mobile devices. These five equities, often referred to as the “FAAMG” stocks, recently comprised approximately 23% of the S&P 500 Index and were up about 59% for the year as of September 1, 2020. The other 495 stocks in the S&P 500 were up approximately 1% for the same time period.1   

Exhibit 1 - Diverging Returns as of September 1, 2020.

The best performing sectors of the last decade through June 30, 2020 were technology and consumer discretionary stocks. Alternatively, energy, telecom and material stocks significantly lagged the broader market. As a result, growth and momentum stocks have dramatically outperformed value stocks over the last 10 years, with large cap growth stocks returning 16.6% annually versus the 10.9% average yearly returns of large value stocks. In addition, there was a similar divergence between the performance of large cap stocks and small cap stocks, with large cap stocks outperforming small cap stocks over the same period by an average of 3.5% per year, 14.0% versus 10.5%.

Another result from the increased concentration of larger stocks was the continued outperformance of capitalization-weighted indices (larger market-capitalization companies comprising a greater portion of the index) relative to strategies that utilize an equal-weighted approach, such as each stock comprising 0.5% of a portfolio. For the first six months of 2020, the cap-weighted S&P 500 Index was down just 3.1%, compared to down 10.8% for the S&P 500 Equal Weighted Index. Comparing returns of cap-weighted and equal-weighted indexes can highlight the performance gap between the largest stocks and the average stock.

Looking across the global equity market, the United States was the best place to be over the last 10 years through June 30, 2020. U.S. large cap stocks outperformed both international developed and emerging market stocks significantly, returning 14% annually compared to 5.7% and 3.3% for international developed and emerging market stocks, respectively. Many of the same U.S trends occurred in the international markets, as growth stocks outperformed value stocks and large cap stocks outperformed small cap stocks.

Implications

What do these divergences in returns mean for your investment portfolio? Investments routinely go through prolonged cycles with stocks of differing geographies, sizes, and styles, as well as with differing risk and return characteristics, going in and out of favor. Unfortunately, it is impossible to predict the timing, duration, or magnitude of how and when such cycles may occur.

If we go a little further back in time and focus on the last 20 years through June 30, 2020, a completely different story emerges. Large cap growth stocks and large cap value stocks provided investors with very similar results, with annual average returns of 5.9% and 5.7%, respectively. Over the same period small cap core stocks outperformed large cap core stocks by almost 1% per year, returning 6.7% compared to 5.9% annually, demonstrating just how unpredictable returns can be. This longer-term view highlights the importance of having a fully diversified investment portfolio with exposure across different investment styles, sizes, and geographies.

We continue to focus on the importance of being long-term investors and developing an asset allocation that is aligned with your risk tolerance and return objectives. Determining the appropriate portfolio mix can help investors reduce risk through diversification by investing across various asset classes and sub asset classes that behave differently over time. While this approach might not always produce the highest absolute return, it should protect against significant losses caused by concentrations in any one area of the market.

It is easy when looking at the last 10-plus years to wonder why your portfolio was not solely invested in the FAAMG stocks of the world. However, for every historical period where growth stocks have outperformed value stocks, we have seen other periods where value stocks have outperformed growth stocks. The cyclical nature of the stock market is a direct result of how economies function and is likely to persist in the coming decades.

Diversification is an explicit recognition that we cannot know the future with precision. Innovest is committed to the investment philosophy of process over predictions, including clients sticking to their long-term asset allocations and rebalancing their portfolios along the way. This process may not be as exciting—or hazardous--as discovering the next set of FAAMG stocks but is a proven strategy that can increase the chances of financial success.