Questions of rebalance discipline and broader reallocations arise as a few names drag equity markets above record levels
The S&P 500 keeps breaking records, and it does so driven by a few mega-cap names. Advisors would be forgiven for feeling a bit of déjà vu reading that last sentence. The story — with a few notable exceptions — has been the same since October of 2023. US equity markets climb higher and higher, but with record outperformance by a select few mega-cap leaders, largely connected to technology, AI, GLP-1 drugs, or another mega narrative.
A bull market with significant outperformance by the largest stocks and leading sectors raises a host of issues for advisors to manage. There is a growing concentration risk as a few names comprise a higher and higher percentage of major indexes. There are also questions of when to rebalance, because as much as we think things are changing, the dynamic of mega-cap outperformance hasn’t been proven wrong yet.
“You’re caught between the two sides of it,” says Elliot Johnson, Chief Investment Officer at Evolve ETFs. “You can’t not participate, which means you need the mag seven, or mag six, or some combination of the 10 biggest US companies. It seemed like that mag seven trade was off in the first quarter of this year, and then it took back hold again. So you need to make sure you have a big enough scoop of Nvidia on Microsoft. On the other hand, you don’t want to look crazy and miss out on a broadening and I think there are reasons to believe that broadening will happen, if it hasn’t already begun.”
Johnson argues that the spark for a broader rally in equity markets may well be a shift in US Federal Reserve interest rate policy. He expects that some form of a cut will come this year, though it’s coming later than many had predicted. When the US embarks on its cutting cycle, Johnson believes that will be supportive for equities as a whole, with broader price appreciation among stocks typically occurring as rates fall.
Even in a broader rally, Johnson believes the tech sector will continue to play a leadership role. Rather than the largest names in tech, however, he is more constructive on the broader technology sector. That leadership, he says, is not because of the novelty of these companies anymore, but because tech has established itself as the market leader in rallying cycles for much of the past 30 years. Johnson advocates for somewhat wider tech exposures, such as a selection of the roughly 40 technology names listed in the Nasdaq 100.
As advisors wait anxiously for breadth to return, Johnson sees an argument for equal weight exposures being made. He notes, however, that equal weight allocations can come with their own risks. They’re set to outperform in a broad rally, but if this concentrated rally continues then an equal weight strategy will underperform. If advisors are considering a shift to equal weight, he believes they should make that shift gradually, taking some profits from their cap-weighted S&P500 exposures and moving them into equal weight.
When making calls for what could transpire, Johnson sees value in getting paid to wait. He notes that covered call equity strategies have become increasingly popular in Canada thanks in large part to that need to be paid an income while retaining exposure to a particular equity play. He suggests that income could help with any advisors’ choice to move towards equal weight allocations.
Surveying risks in this bull market, Johnson sees the decisions made by Fed Chair Jerome Powell as the single largest source of risk right now. However, it’s very hard to mitigate risks associated by macro forces like fed decisions. In this environment he believes that first principles and discipline can be helpful. That includes rebalance discipline which, despite the temptation to keep riding this bull market, can help an advisor demonstrate their value in the long-term.
“Bull markets are a hard time for advisors to convince their clients they’re adding value, because everything looks so easy. It’s when you go through a bear cycle that you see value,” Johnson says. “I think most advisors right now are having really good conversations because they went through that terrible equity and bond market sell off that ended in Q4 of last year, things have rebounded, and now people are feeling pleased that they stuck with the plan.”
