When Index Concentration Is High, Consider Quality Companies as an Investment "North Star"

The S&P 500 is up significantly in 2023, but the rally has been narrow, with a handful of big stocks driving the market. The fuel? An expected Fed rate cut earlier in the year and a snapback from weaker 4Q 2022 returns. More recently, the drivers have been a flight to “safety,” given that many mega-caps lack exposure to banking woes, and the rapid adoption of artificial intelligence.

In past periods when a small number of stocks have led market returns, performance has tended to broaden significantly over six- and 12-month periods. Over the past 30 years, when equity returns have become particularly concentrated, a broader swath of stocks has then outperformed in 13 out of 14 periods.

Historical analysis and current forecasts do not guarantee future results.
*The highlighted data points in the line chart are month-end values. The May 2023 data point is high but may not yet be the current peak.
Through May 31, 2023
Source: Morningstar and AllianceBernstein (AB)

The market’s most recent move to “higher ground” wasn’t surprising given concerns over a slowing economy—many forecasts pointed to the best-telegraphed recession in recent memory. Today, the S&P 500’s top 10 largest stocks now trade at a substantial premium to the rest of the benchmark (25.9x vs. 14.6x).

Against this backdrop, we believe that pursuing high-quality growth stocks should be paramount—and that high-quality growth isn’t the exclusive property of the 10 largest companies. Firms with high profitability (such as high return on assets or return on equity) and durable profit margins, accompanied by strong financial backing, have delivered favorable returns when earnings growth has been waning. We believe that these attributes will remain coveted in this environment.

Past performance does not guarantee future results.
*Based on market capitalization
EPS: earnings per share; P/FE: price to forward earnings; ROE: return on equity; ROA: return on assets. Figures shown represent S&P 500 factor performance high to low (Q1 vs. Q5), sector adjusted. 
As of May 19, 2023
Source: Bloomberg, Piper Sandler, S&P and AB

The Takeaway

We believe that, over time, emphasizing a diverse mix of quality stocks that goes beyond the biggest companies can be a solid foundation for excess return potential throughout economic cycles.

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