Clients frequently ask what we expect the S&P 500 Index (“S&P 500”) to return in a given year. Our answer is nothing if not consistent: we do not know (and are wary of those who claim they do). However, we have been building an analysis set for some time now that indicates that institutional biases increasingly emphasize liquidity needs for their enormous pools of capital over investment merit, all in the name of reducing volatility.
At the index level, this trend is reflected in the prevalence of the float‐adjusted market capitalization weighted index construction methodology, the results of which include increasingly top‐heavy indexes and the exclusion or under‐representation of smaller or more closely‐held companies, even of entire industry sectors. Unfortunately for index investors, the same large companies that dominate index returns also face the greatest challenge with respect to future growth. How can a company with a $100 billion sales base generate enough incremental sales each year to move the needle when it has already saturated its market? Complicating matters further, since investors wish to experience low volatility, the company with a $100 billion sales base is expected not only to increase its revenues and earnings materially, but to do so in a manner that does not result in a variable earnings stream or stock price.
In the face of these two seemingly antagonistic goals, the largest corporations appear to be favoring risk reduction over long‐term value creation. One way of measuring this trend is to use the basic corporate liquidity measure, which is cash as a percentage of assets. The following table shows this measure for the 12 largest nonfinancial companies in the S&P 500; this discussion considers only nonfinancial companies because cash as a percentage of assets for Bank of America, for example, is not a meaningful figure. Note, too, that the top 12 nonfinancial companies in the S&P 500 happen to comprise 19.83% of the market value of the entire index, which is not a small number.
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