From a Canadian perspective, it is amusing to see anyone complain about the top-heaviness of the S&P 500, given what Canada's benchmark index looks like these days.
The S&P 500, of course, consists of the biggest U.S.-based companies – with Apple Inc. at the top – but the value of these stocks can shift as names move in and out of favour.
Right now, 49 stocks account for half of the S&P 500's market cap, feeding concerns that the benchmark index isn't representative of the U.S. market – and, more importantly, that a slide by a handful of names could have a nasty influence on the rest of the index.
Bespoke Investment Group put these concerns into perspective, though. Going back to 1980, the average number of stocks making up 50 per cent of the S&P 500's market cap has been 51.
Therefore, today's level is actually in line with the historical average and well above the low of 33 seen during the craziest days of the tech bubble in 1999, when technology stocks dominated and made the index susceptible when the bubble burst.
Similarly, Canada's S&P/TSX composite index also doesn't look too top-heavy on the basis of the number of companies it takes to make up half the index's market cap. Right now, 30 companies – led by Royal Bank of Canada, Toronto-Dominion Bank and Bank of Nova Scotia – represent half the index, and that is with 249 index members.
Expressed as a ratio, the TSX is actually more diversified than the S&P 500.
But sector weightings tell a very different story, and given that individual stocks tend to move with their peers – due to a changing economic outlook, shifting trends and swings in commodity prices – this is arguably a better way to size up top-heavyness.
In the case of the S&P/TSX composite index, three areas dominate: Financials comprise 32.1 per cent of the index based on their weighting, energy stocks 25.6 per cent and materials 18.7 per cent.
Put another way, the top three areas make up an amazing 76.4 per cent of the benchmark index in terms of their weightings, making the index a big bet on banks and commodity producers.
Technology stocks, health-care stocks and utilities have weightings of less than 2 per cent each, making them all but invisible.
By comparison, the S&P 500 is far more diversified. Technology stocks have the biggest weighting, at 19.3 per cent, followed by financials at 15 per cent and health care stocks at 12.2 per cent.
Here, the top three areas have a combined weighting of 46.5 per cent – or 30 percentage points less than the TSX.
In other words, when you hear anyone complain about the S&P 500's lack of diversification, first chuckle and then point to Canada's benchmark index: If diversification is what you want, you won't find it here.
David Berman