Face Reality: Pit Yourself Against Nasdaq 100

Beware how you or your investment advisor measures performance. With recent additions and deletions, the Dow Jones Industrials looks more and more like the S&P 500 Index. Both indices strive to maintain some relevance. Tesla TSLA just left Nasdaq 100 Index NDAQ for the S&P 500. Hiding in the S&P 500 no longer is Mickey Mouse stance.

All three indices retain a vested interest in relevancy. They earn plenty of money from those of us who periodically check-in for historic index updates. Even guys writing market letters on their wives’ ironing board need updating on market stats. 

Nearly the entire wealth management industry, measured in tens of trillions, employs the S&P 500 Index in client performance reports. Even hedge funds use the S&P 500 for basing performance fees. Getting away with murder, because in terms of sector concentration and market volatility they should be referencing the Nasdaq 100 as their yardstick for incentive performance fees.

Actually, several sizable hedge funds mimic the Nasdaq stocks heavily weighted in this index. Consider, Apple AAPL , Microsoft MSFT , Amazon AMZN , Alphabet and Facebook account for nearly half the weighting in Nasdaq 100. Tesla deporting to the S&P 500 rests under a 3% weighting switch.

Long-term viability of the S&P 500 and more so Nasdaq 100 are dependent on performance of half a dozen e-commerce and internet properties along with Microsoft. Past five years, this handful of growthies powered the bull market’s gain, ranging near 400% for Microsoft and Amazon. Throw in Apple.

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Aside from poor performance numbers, a basketful of industrials in terms of their market capitalizations, are no longer relevant except as cyclical recovery candidates. Starting with General Electric GE and going down to U.S. Steel, Alcoa AA , Ford Motor F , DuPont and Macy’s M , this list of also-rans is extensive. These are now mid-capitalization stocks at best.

Even Exxon XOM Mobil is bordering on irrelevance with a market capitalization of $160 billion, once over $400 billion. You could put Exxon’s market capitalization at least four times into Tesla. Exxon’s history as to public ownership goes back to the late 19th century, a Rockefeller property. By comparison, Tesla is an infant.

First thing to look for in any index is sector concentration. Technology is half Nasdaq 100 vs. low twenties for the S&P 500. In stock concentration, five stocks – Apple, Amazon, Microsoft, Alphabet and Facebook comprise half of Nasdaq’s stock weighting. Tesla was just a 3% weighting. This index stands or falls on tech. Call this a maximum-intensity asset structure.

No major, serious wealth management organization, say JPMorgan Chase JPM or even Fidelity Investments, would ever dream of putting in jeopardy money management performance, risking major underperformance, seeing asset shrinkage and mass exodus of its clientele. Such institutions opt for mediocrity, hopefully shadowing their indices of measurement. Clients accept unexciting numbers, but feel secure that their net worth isn’t seriously at risk. The wealth management sector for banks can run over 10% of overall profits and maintains a growth bias just so long as asset shrinkage is minimal.

Twenty years ago, General Electric dominated the S&P 500 with a market capitalization of $415 billion. Weighting for Microsoft barely exceeded Exxon Mobil, numbers two and three in this listing. Citigroup C surprised me in fifth, a 2.2% weighting. In the financial meltdown of 2008 – 2009 Citigroup nearly succumbed, ridden with foolishly written home mortgage paper. Market capitalization melted away.

Performance determinants of the Dow, S&P 500 and Nasdaq 100 did change markedly over recent years. There’s a defined bias towards growth stock inclusion in all three indices, even the Dow Jones Industrials which no longer defines its make-up.

For the Dow in December 2014, ten largest market capitalizations were slotted by industrials and financials. No growthies but nearly 30% of the weighting in Visa, Goldman Sachs GS over 16% of weighting. Boeing BA , United Technologies UTX and 3M Company MMM , another 15% index share.

The Dow more ‘n’ more resembles a growth index. I was surprised by its top three names – UnitedHealth Group UNH , Home Depot HD and Salesforce.com nearly at a 20% weighting. Oddly, Apple sat at 2.5% but Microsoft at 4.7%. So, the Dow, with all its additions and deletions, became a cockamamie-growthie index. What’s Travelers doing at 3% but Coca-Cola KO at 1%? Gimme a break!

Finally, we get to Nasdaq 100 which I hold stands alone as the keenest performance measurement. Past year, Nasdaq 100 rose 100%, but only 50% for the S&P 500. Institutional money managers rarely even mention Nasdaq. The entire hedge fund industry should be measuring itself against Nasdaq but they don’t do it and get away with it for client performance measurement as to earned performance fees. Everyone uses the S&P 500 Index because it’s easier to beat.

Look at Nasdaq 100’s top 10 positions, the real world. It embraces trillion-dollar market capitalizations extant. Nearly 50% of Nasdaq’s market weighting is comprised of five stocks – Apple, Microsoft, Amazon, Alphabet and Facebook. This handful of growthies governs market performance. As reported in the financial press, Dow Industrials rates more space and airtime than the S&P 500 and Nasdaq combined.

This is dangerous dumbing-down of daily financial news which everyone accepts as gospel. My father would call the Dow Jones a son-of-a-bitch on its down days. Investors need to listen up and appreciate the changing structure of indices over time. Today, half the S&P 500 Index is comprised of technology, financials and healthcare. Utilities and energy stocks under a 10% weight with industrials at 9%.

Decades ago this shopworn paper dominated the index. General Electric’s market capitalization once over $400 billion was equivalent to today’s Apple, Microsoft or Amazon.

Everyone should thirst for outstanding investment performance. There’s no question that Nasdaq during 2020 was the place to be.

Reason most wealth managers underperformed in 2020 was simplistic:  Light in technology and too cautious in the fixed income sector. Little or no high-yield paper. Let’s hope high net worth families (those with eight to nine-figure assets) retain more capital than they ever expect to spend. But, past years, their wealth managers didn’t come through.

Clients were subjected to voluminous quarterly reports that obscured poor performance. Hiding in Treasuries, AAA corporates and the S&P 500 Index aside from farming-out capital to outside managers was a loser’s game. Sooner or later the Nasdaq 100 will wax overpriced and react more than the S&P 500 in a down market. Today, I can rationalize the valuation structure of high-tech names to the extent they’re growable, not priced for perfection.

Who dares blow his whistle and check out of growthies? Bathed in irony, these trillion-dollar beauties consistently defy extrapolations by the analyst fraternity. Such statisticians carry no credibility, widely missing on their numbers, quarter-after-quarter.

The recasting of the S&P Index, making it more growth-oriented is a silent gift to passive investors. Their investment advisors thereby get pushed further towards a growth construct, away from the Exxon Mobils of the investment world.

Sosnoff and/or his managed accounts own Microsoft, Amazon, Alphabet, Facebook, General Electric, U.S. Steel debentures, Ford Motor bonds, Macy’s, Citigroup and Goldman Sachs.

msosnoff@gmail.com

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