As top technology companies seemingly dominate the markets, is this time different for future investment returns? In other words, are these tech companies so revolutionary that they will continue to provide the highest investment returns for many years in the future? – OR – Is it possible the short-term returns of the few top tech companies are disconnected from economic reality and we’re being set up for the fall…again? (e.g., 1999)
Some might try to predict the future but if they were truthful they would admit the answers to these questions are unknowable. Luckily we don’t have to know the future because we have history to learn from. Admittedly this is much less exciting than looking into our crystal ball but we’ve experienced times similar to these in the past.
One of my favorite financial podcasts and bloggers of “A Wealth of Common Sense”, Ben Carlson says:
“Maybe the biggest risk for most people is assuming they know exactly what happens next. I don’t attempt to predict the future but I do believe you can create probabilities based on the past to analyze the present. That means accepting that I don’t know what’s going to happen, but being informed sufficiently to build a diversified portfolio that’s durable enough to withstand a wide range of outcomes.” -Ben Carlson
Revolutionary Technology is Nothing New
Throughout U.S. history, there have been companies inventing revolutionary technology and dominating the stock market. For example, AT&T began its history as Southwestern Bell Telephone Company, a subsidiary of the Bell Telephone Company, founded by Alexander Graham Bell in 1877. The Bell Telephone Company became the American Telephone and Telegraph Company in 1885 and was later rebranded as AT&T Corporation. There are many other examples of high-tech companies of their time such as GE (originated from the Edison General Electric Company), Exxon, GM, and Dupont.
As you can imagine, because these companies were so revolutionary they were also extremely profitable. In fact, the previously mentioned companies along with a few others made up about 27% of the S&P 500 in the early 1930s. Currently, the largest ten stocks make up about 25% of the market capitalization of the S&P 500.
In another podcast I enjoy listening to called The Rational Reminder Podcast, Ben Felix discusses how the ten largest companies in 1930 went on to underperform the overall market in the following decade. What’s even more interesting is that Ben Felix further explains how the ten largest companies at the beginning of each decade since 1930 have underperformed in the following decade, every decade, starting in 1930 and continuing through the decade ending in 2020.
“…the ten largest companies at the start of each decade made up on average 23.6% of the US stock market…the average annual return of the ten largest companies for the decade following…trailed the overall market return on average by an annualized 1.51%.” -Ben Felix
Let me be clear, it’s okay to own the ten largest companies in your portfolio. I’m sure most of us do. However, we as investors have a tendency (recency bias) to think that current outperformance must inevitably continue in perpetuity. Clearly, history has shown otherwise.
Differences in Expectations Drive Short-Term Fluctuations
It is often said that stock market performance isn’t affected so much by what actually happens in the economy or to a specific company in the short-term but rather more about what was better or worse than the expectations of the market. For example, have you ever seen a company’s stock price go down after they reported positive earnings? Clearly, even though the news was positive in this example, the profit expectations of the company were not met. I believe this is the reason the largest ten companies typically underperform the following decade. Furthermore, the price people pay for popular stocks already have high future expectations priced into the stock. For example, it would take extraordinary innovation from Apple to surprise customers and further exceed their already high expectations.
“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.” -Warren Buffet
In summary, it is beneficial to learn from financial history and maintain awareness of our behavioral biases that affect our financial and investing decision-making. In this case, our recency bias causes us to project the most recent “hot-stock” investment returns well into the long-term.
Finally, although like watching paint dry, investment diversification and global asset allocation of stocks and bonds will give you the best chance for achieving your required investment returns and retirement goals.
Don’t try to buy yesterday’s investment returns. It’s often compared to driving while looking in the rearview mirror.
Allow Myself to Contradict…Myself, Ben Carlson, A Wealth of Common Sense
Rational Reminder #113, The Rational Reminder Podcast, Youtube Video
Chairman’s Letter – 1982, Warren Buffet, Berkshire Hathaway Inc.