It seems there is a heightened correlation between market volatility and the number of narratives explaining why stocks perform the way they do. Those narratives are often riddled with hindsight bias (how people explain that which has already happened). In conversation, it can be enlightening and entertaining. However, it can be costly when it influences the decisions you make regarding your investment portfolio or your financial plan.
There have been plenty of narratives explaining why the FAANG stocks have been producing incredible returns in spite of this market (Facebook, Amazon, Apple, Netflix, and Google). This leads some investors to question why they would be holding any other positions if it obvious these companies will continue to dominate the market in the future. This led me to look even further back, specifically at the largest 10 companies in the world by market capitalization (1).
10 largest companies by market cap
Now I know this is not a true apples-to-apples comparison. The market composition has changed, this time is different, and so on and so forth. However, I believe that while history does not repeat itself, it does seem to rhyme.
Now try to imagine yourself in any one of these time periods. I first thought of Nokia dominating the mobile phone industry in 1999. I think of Microsoft facing a lieu of anti-trust allegations in the late 90s and early 2000. It is hard to imagine Exxon being one of the top four largest companies in the world for 15 years, only to see it’s market cap fall over 30% over the next five years. Cisco was up 236% between January 1st, 1999 and March 27th, 2000! (It fell nearly 70% in the four years following.)
So, how have these companies fared since they achieved a place among the titans of the market? I compared the returns of each of these companies to a total domestic equity market index fund (VITSX). I created a hypothetical portfolio containing the top-ten largest companies weighted by market cap (largest company gets more weight). This table shows the outperformance of the top-ten portfolio against the total market index (green for outperformance in favor of the top-ten portfolio and orange for underperformance).
Performance of top-10 portfolio vs. VITSX
The table shows that the top-10 portfolio is more likely to outperform in the short run and underperform in the long run. What does that mean for someone who wants to catch the big fish? Well, you would have to turn your portfolio over quite often to outperform a broad-based index fund. You would need to have the audacity to bet against Nokia in 1999 or sell Cisco after a 233% return. The only company you would hold from 1999 through today is Microsoft. If you are wrong, you sacrificed long-term financial confidence to chase short-term gains.
Apple, Microsoft, Amazon, Alphabet, and Facebook are the top five largest public corporations in that order. There is only one FAANG stock not on the top-ten list right now – Netflix. It is easy to think that these companies will continue to drive the returns of the market. After all, how could any company compete with the likes of these giants?
We have told that story before. We will tell a different story in hindsight. It can be hard to know when you are speculating. Just remember, your financial plan is a tool to mitigate this bias.