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Technology has re-shaped the S&P500

  • 2000 25 Jan
Technology has re-shaped the S&P500
Reprinted with permission from World Finance Net IPO Newsletter, written by Maureen Wells.

Technology Has Re-Shaped S&P500
Here's what is in your index fund

The splendid rise of the technology sector of the U.S. stock market in 1999 has not only left investors richer, but in the process has remolded one of the most popular of mutual funds, those based on the S&P 500 index. Evolving to reflect the rise of technology companies in the economy, the S&P is not the index it used to be. So in the interest of knowing what you are buying, lets take a look at some of these changes.

First of all, technology stocks now make up a record 30% of the S&P 500, a significant change. Only three years ago, the techs represented a mere 13 percent of the total index. During the same period, parallel changes are detected in the trailing price-to-earnings ratio from an average of 19.1 to a rise of 33.4, now. The instigation for these changes came in the form of a blistering rally in big technology stocks such as Microsoft and Intel.

The dynamics of concentration have also changed. Currently, the S&P 500s biggest members make up a larger portion of the index than at any time since the early 1970s, when the so-called Nifty Fifty (top 50) stocks dominated the market. Now, the S&Ps top 10 stocks, led by Microsoft, Intel, General Electric and Cisco Systems account for almost 25 percent of the indexs value. This switch in concentration is also affecting the index's performance as well.

These same top ten stocks in the index returned the lions share of the profits, 38.8%, on average, compared with just 4.4% for the bottom 200 companies, according to reports published by the Leuthold Group in Minneapolis. And if all of the technology stocks were removed from the S&P Index, its return last year would have sunk to a miniscule 3.1% instead of the robust 21% it did deliver.

Strong performance numbers earned by the top 10 stocks are creating somewhat of a cyclical trend. Because the top 10 are doing well, these stocks are pushing returns of the S&P Index higher. Attracted by the good performance of the index, investors buy into the fund. With the new cash, the mutual fund manager has to buy more of the top ten, propelling the price of these stocks even higher.

The best selling of the indexes for the past four years has been Vanguard 500 Index Fund, which has assembled about $104 billion in assets. It opened its doors in August of 1976 as the first indexed mutual fund. The funds size has doubled in the past two years, alone, and is expected to shortly pass Fidelity Investments Magellan as the worlds largest mutual fund.

With the sheer size of the fund representing a goodly portion of Americans investment dollars, some analysts are speculating on the impact of a technology tumble, now that the techs represent 30% of the index. If the tech stocks head south after their recent run, investors may start looking for the next hot sector and start redeeming shares. Because theses portfolios hold no cash, wide scale redemptions can bring more suffering to index fund investors than realized. In order to maintain the index ratio, 30% of stock sales to meet redemptions would come from technology stocks pushing this sector to decline further.

The technology worry-warts point out that no single sector dominates the market, always. Remember those Nifty Fifty stocks that led the market in the 1960s, companies such as International Business Machines, AT&T and General Motors? Over the following ten years, these stocks lost an average of 1.1% a year. What goes up does not go up forever. Looking back to the end of the 70s, six of the top ten names in the index were oil companies. Only one oil company holds that distinction now and it is monster Exxon Mobile Corporation, which had to merge earlier this year. And at the beginning of the 1990s, only one technology company was included in that top ten, and that company is IBM.

On the other hand, there are those market analysts who point out that, over time, the S&P Index has absorbed the rise and fall of a variety of economic sectors without disrupting the stock market in the process. Changes in the composition of the index are but a predictable reflection of an ever-evolving American economy. Different sectors lead the market at different times; it is a normal economic process. That the S&P 500 index has a track record of 25 years recording a relatively low level of volatility tends to support this point of view. So if history serves as preview of the future, the S&P Index will in the end withstand the decline of technology stock valuations as well. Because the techs hold such a large percentage of indexed assets, the ride may be a little bumpier this time.

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