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By Tony Barchetto, CFA
Many market participants have decried the gains in the market this year as the product of narrow participation from just a group of mega-cap stocks such as Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and Apple (NASDAQ:AAPL). The S&P 500 in 2018 has not been a straight line up but did recover from the February swoon to notch a 10.6% total return for the year through the end of September.[*]
The FANG trade (or FAANG, FAANGM, or whatever acronym you prefer) has still been a workhorse in 2018, although it cooled off a bit from its torrent pace in 2017. The NYSE FANG+ Index, an equal-weighted basket of Facebook (NASDAQ:FB), Amazon, Netflix, Alphabet (Google) (NASDAQ:GOOG) (NASDAQ:GOOGL) plus Apple, Twitter (NYSE:TWTR), Tesla (NASDAQ:TSLA), Nvidia (NASDAQ:NVDA), and Chinese high-flyers Alibaba (NYSE:BABA) and Baidu (NASDAQ:BIDU), rose close to 92% in 2017 and then another 25% through Q3 year to date in 2018[*]
But how do these gains compare to the broader market? One way to measure is to look at the top contributors to return in the S&P 500. This shows a clear link between the return from an individual stock and its impact on the return of the whole index. As a cap-weighted index, the dominance of any large move in very large stocks will have an outsized effect on the index level - that's just how the math works. But looking at this dominance in proportion to the total return for the year can offer some insight on how narrow or broad the participation is in market gains (or losses).
Through the end of the third quarter, the top 5 contributors to S&P 500 return were responsible for 42.4% of the 10.6% YTD return.[*] That sounds like a lot. But is it really?
After all, just one stock - Amazon - is driving 14% of the gain. The top three (Amazon, Apple, and Microsoft (NASDAQ:MSFT)), all mega-cap tech, are together 36% percent of the gain. How unusual is this historically?
To answer the question, we looked at the same contribution to return analysis for the S&P 500 from 2000 through today. We focused on the top 5 contributors to return in the same direction as the market. For example, if the market was down for the year, we looked at the top 5 negative contributors and vice-versa. Then we calculated the proportion of the annual return that is attributed to those top 5 for each year (shown below overlaid on the return.)
Source: Bloomberg, Salt Financial calculations
The larger the gray area in respect to the total return, the narrower the contribution. For years with relatively small returns in either direction (2000, 2011, or 2015), the top contributors were greater than 100%. In other years (2008, 2013, 2016), the market made a more monolithic move with the top 5 driving less than 15%.
An easy way to smooth out the data to give it more meaning is to calculate a weighted average of the top 5 as a percentage of the total. This gives more weight to larger return years in either direction that were dominated by a handful of stocks. A 30% return with 5 stocks driving 50% is more interesting than a 2% return with 100% led by 5 stocks.
On this measure, the weighted average top 5 contribution was 25.5% from 2000-2018. This is probably higher than the average person would guess - it's still a lot of kick from just a few stocks. But given the nature of a cap-weighted index, it is quite normal. But by this standard, 2018's top 5 contribution of 42.4% is definitely more extreme. In fact, it's the highest value for any year with double-digit returns (up or down) since 2001 (48.5%).
Some of the most successful technology companies in the world have climbed to the top of the heap in the S&P 500 in terms of market cap. It should not be any surprise they are the market leaders today, displacing the likes of General Electric (NYSE:GE) or Exxon Mobil (NYSE:XOM) from years past. But this does not mean they are without risk - or that smaller stocks beneath the surface are not having more trouble than the index might suggest. As an investor - large or small - it would be extremely difficult to outperform the market without owning some or all of these top 5 when the contribution to the index return is this high. But that could of course change on a dime.
[*] All return figures sourced from Bloomberg
 We used the total return of the S&P 500 index but the Vanguard S&P 500 Index fund (MUTF:VFINX) to look through the components and perform the attribution analysis. All contributions to return were sourced from Bloomberg's PORT function There are slight differences between an index fund return and the total return index due to tracking error and fees, but these are immaterial in respect to the contribution for an individual stock.
 A list of the top 5 positive/negative contributors by year is available for download here. All figures sourced via Bloomberg.
 Salt Financial calculations based on Bloomberg data
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