Ideas Farm: Titans don’t stay atop forever

Even the fear of rising interest rates has been unable to halt the upward march of the US stock market, as Big Tech shares rebound from their stumble last month. The pandemic has played into the hands of these tech giants, accelerating the shift to a world where we are more reliant on e-commerce, cloud computing and digital communication.

Looking at the roaring success of the likes of Amazon (US:AMZN) and Microsoft (US:MSFT) over the past year, it is hard to imagine a world in which these companies don’t dominate the equity markets – or indeed our everyday lives. But Joe Steidl and Tiffany Su of Research Affiliates caution against the assumption of permanent top dogs.

“[N]ever underestimate how drastically the playing field can change, even in the most unlikely of circumstances,” they wrote in a recent note. “Against all odds, even the most powerful can fail.”

Steidl and Su liken the process to the Titanomachy in Greek mythology – the great war that occurred between the older Titans and younger Olympians. They observe how the “rulers of the equity market” – considered to be the companies with the largest market capitalisation – can hold onto their top positions for a long time, perhaps even decades. But eventually they can fall.

As such, there has been a dramatic shift among the world’s 10 largest companies over time. While the oil and gas majors dominated the 1980s, and the Japanese conglomerates were the titans of the 1990s, fast forward to today, and it is US and Chinese tech stocks that tower above everything else.

Looking at a global market-cap weighted index, Research Affiliates found that the concentration of the top 10 stocks reached an all-time high of 17 per cent in September 2020, above even the 14 per cent seen at the height of the dotcom bubble. Given the outsized returns of these companies compared with the rest of the index, that may not seem like a problem.

But Steidl and Su argue that there is “the potential for underperformance of these (likely overvalued) stocks and the portfolios that hold them”, particularly as retail investors gravitate towards these companies and place upward pressure on their prices and valuations.

Their solution to this concentration risk is to diversify your portfolio to include a combination of value, quality, low volatility, momentum and small-cap holdings – a so-called “multi-factor” strategy that can provide smoother excess returns throughout the economic cycle. While that may sound obvious, it is not always easy to rotate away from the allure of growth stocks.

But bear in mind that the corporate titans of today may not be the ruling overlords in the coming decades. Only Apple and Microsoft have remained in the top 10 since 2010, and even the mighty Apple could lose some of its lustre amid the rising ‘techlash’. The aftermath of its legal tussle with Fortnite developer Epic Games could prove to be more than just a bump in the road.

Meanwhile, China is cracking down on its tech giants, and while Tesla has stormed up the rankings, can we be sure that it will still be the leading electric vehicle maker as other manufacturers race to catch up?

No one knows what the future will hold, but history suggests that investors would do well not to get too attached to today’s titans. For inspiration on how to diversify your portfolio, check out the data in our Ideas Farm below.