(especially if you do not live in the US)
Last week the biggest US tech names reported their Q2/21 results:
Tesla, and to a lesser extent Netflix, starting point was low enough that an almost triple-digit growth is still in the realm of possibility but the other names on the list? You are not supposed to grow that fast when your revenues are already in the hundred of billions, and yet…
Michael Batnick created this now infamous pie chart for the first time in 2018 and this is the updated version as of August 2020:
As you can see, these five stocks are not big, they are a huuuuuge part of the S&P500. And rightly so, as they prove quarter after quarter after quarter. The index is called 500 but if for any reason you happened to miss one you these FIVE names, your results would be quite far from the index itself. 5 names out of 500 is just 1% of the index; on the other side, you could erase 100 names at random out of the remaining 495 (ok, the index is not exactly 500 names but you get the point) and you would still have matched the overall index quite closely.
Average stock market returns are not so average
Recently Banker on Fire updated his version of a post that every personal finance blogger out there has wrote at least once in their career: the path to arrive at one million net worth. The strategy is quite simple: save as much as you can, invest and let compounding do its magic; as soon as you pass the first 200k, you reach ‘escape velocity’: the returns on your portfolio do the heavy lifting instead of your regular savings.
The speed at which you reach your final goal depends on the rate of return you assign to your investments: the higher the rate, the faster you get there. In this regard, the S&P500 is the universally utilised benchmark. As for many ‘movements’ in this world, personal finance was born in the US: if I am a US based investor, it makes sense for me to look at the local, most representative index. It also does not hurt that this index was the best performing index in the world (I do not think it is a coincidence neither that the country with the most successful financial performance gave birth to personal finance, retail stock investing, F.I.R.E. and so on). But what if I was born in Italy? This ‘consensus’ around a very specific index raises two issues in my opinion.
- Home Country bias
The S&P500 is the FAAMG equivalent to the World Stock Index.
Imagine you are an American diligent saver and investor, tomorrow you read a post like the BoF above but instead of 8%, the author uses Google performance as benchmark return. You read how easy is to arrive to TEN millions in 15 years. Then you start to dig more into the topic and you realise that all the clever people out there are using Google as their benchmark. And they use it because they actually invested their savings in it.
You feel stupid. Everything you read before was about the S&P500, why all of a sudden everyone’s universe is just about Google? You look at your past performance and feel bad, demotivated.
This is the experience of a lot of investors living outside the US: national newspapers, financial magazines and TVs devote the majority of their coverage to local companies…and local stock indexes. I remember an Italian article talking about the “Dogs of the Dow” strategy and concluding with the ten Italian names that you should buy if you wanted to use the same approach. The general lingering assumption is (was?) that stocks are stocks, your local index can be a suitable proxy as any to get stock exposure in your portfolio.
Or was I too naive? Was the truth in front of me, if only I dig just a bit deeper? I asked myself if investors starting now would experience the same. On one side, information travels faster and faster, the S&P500 had such an overperformance over anything else in the last ten years and buying foreign stocks is way easier that I think FAAMGs are probably over-represented in portfolios outside the US. On the other, I have in front of me pension plans in the UK that invest 50% or more in UK stocks; I see model portfolios made by Italian financial planners that are tilted towards Italian assets…and not because the ‘ignorance’ of the planner but because clients are more comfortable with those names.
I am spending few weeks working from Italy: in this regard I find quite telling the difference in topics that my parents bring at the dinner table compared to the small chat I have with my colleagues back in London. Even if both ‘groups’ can potentially access the same information pool, they gravitate towards what is more familiar to them.
2. Past performance is not indicative of future results
The S&P500 became THE benchmark (also) because US investor home country bias.
Things are changing, as they always do. Single country indexes are less and less representative of a country economy and are even less representative of the world economy. As Josh Brown pointed out in his latest podcast, it was easier in the old economy to find ‘replicas’ of the same business in different places: utilities, banks, consumer staples, each country or continent had theirs. Today, Netflix is competing with your local tv but is listed only in the US.
Stock exchanges also compete globally for IPOs; Spotify was born and raised in Sweden but got listed in the US: if you are a global business you want to attract global capital and few places offer that. Investing in the US for a Swedish investor is easier than investing in Sweden for an American one. As anything else in life, things tend to converge: it is the networking effect, like the value of Facebook increases the more people use it, having all stocks and trading in a single ‘place’ is more efficient.
There are also forces that push in the other direction, against concentration. I started to think about this post looking at what is happening to tech stocks in China. Understanding the Communist Party intentions, and the consequences of their decision, is complicated. The cynic in me thinks that some companies like Alibaba got so big that people like Jack Ma might challenge the power of the Party and therefore the threat had to be stifled. An optimist might see it as an overdue decision that should be followed in the Western world as well.
Facebook is an extraordinary profit machine that created non trivial issues to society; it became so big, organically and via the acquisition of Instagram and WhatsApp, that competing against it is almost impossible (ask Snap). MS Teams is just the latest exhibit on how sometimes Microsoft ‘innovates’. The AppStore and its Android equivalent are a duopoly, agreeing to their terms is more important for any company that any Country legislation.
Maybe for the wrong reason but China offered us a vision that another reality is possible. I do not want to say that one environment is necessarily better than another, just to highlight that the ‘status-quo’ is not a given and anything can change quite quickly. Sometimes profits are a reward for innovation, sometimes they are the ‘haves’ taking advantage of the ‘have nots’.
Conclusion
Using the S&P500 historical returns as a proxy of what you should expect to gain in the future might reveal as a target too high to achieve. The past does not consider all the other possible, and reasonable, choices you could have taken (a sort of survivorship bias) while in the future our society might decide that a different split of profits (higher corporate tax to finance Universal Basic Income?) would be better for everyone. Hope for the best, prepare for something worse 😉
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