Don’t Put All Your Eggs in One Basket

Like many this past weekend, my family hosted an Easter egg hunt. It’s always fun to see what surprise is inside those little plastic eggs. I’m sure most people expect to find jellybeans, chocolate, or even quarters. However, I’ll never forget years ago, opening a bright plastic egg only to discover a rotten egg inside. The surprise was unforgettable.

Growth vs. Value

Some investors may also be surprised at what they find if they open indexes and funds to see what’s actually inside. Over the years, the S&P 500 Index has evolved and looks very different than it did five, 10, or 20 years ago. We typically categorize stocks into growth or value categories. Growth is dominated by the technology sector along with healthcare. Value, by contrast, contains companies within the financials and industrials sectors.

This chart shows the weight of growth stocks versus value stocks within the S&P 500 and how those weights have changed over time. The proportion of growth stocks in the S&P 500 Index has risen dramatically in recent years.

Everyone knows the old adage, “don’t put all of your eggs in one basket.” In investing, this can be a reminder to not rely solely on one index. The S&P 500, a market value weighted index, is actually more concentrated than you may think. Apple and Microsoft make up about 7% and 6% of the index respectively, while the technology sector as a whole makes up for more than a quarter.

After the failures of two regional banks in the US made waves across the financial system, increased fears among investors resulted in a one-day decline of 15% for the regional banking sector. By the end of March, however, due to the internal allocations of the index, the S&P 500 as a whole gained 3.5%, with Apple and Microsoft accounting for almost half of that gain.

At the beginning of 2022, technology stock valuations were at all-time highs. As the Fed hiked rates quicker than anticipated, these growth-oriented companies were disproportionately affected. The Russell 1000 Growth Index was down almost 30% last year while Value was down less than 8%. Fast forward to this year, and growth stocks, dominated by the mega-sized technology companies, are up about 14% through the first quarter of 2023. Declining longer-term interest rates, strong balance sheets, and what some believe to be relatively recession-resistant businesses have buoyed the sector. This second chart shows Value vs. Growth stock performance. When the line is rising, Value is outperforming Growth, and when the line is falling, Growth is outperforming Value.

Controlling for risk

When constructing portfolios, we recognize both the concentration and differences in the total market versus the S&P 500 index. When we add diversifying strategies in to portfolios such as international stocks and small or mid cap stocks, we believe we can better control for risk.

Currently, our view is neutral regarding growth versus value. Within both those segments, we favor companies with higher-quality balance sheets (e.g., less debt) and defensive characteristics. Quality companies may be better positioned to survive and flourish in worsening economic conditions given their tendencies for higher profitability and lower leverage. Favoring them in portfolios potentially adds resilience should we see continued market weakness. While this stance has been a headwind to portfolios in the first quarter of this year, we still believe there is a lot of uncertainty, and our positioning reflects that. It is impossible to time the markets, so owning less-expensive parts of the market is a way to be more defensive and less cyclically oriented.

It is important to understand what you actually own within underlying strategies and overall portfolios and how those strategies will behave during different market cycles. We are disciplined in our investment process and believe we are well positioned to withstand continued market volatility. We are strategically placing our eggs in different baskets. We also like to know exactly what’s in those little plastic eggs as we attempt to minimize any surprises.