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Concentration creates opportunity in large-cap growth market

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      By Lance Garrison, CFAPortfolio Manager, Atlanta Capital

      Atlanta - In surveying the large-cap equity market today, we see three significant trends driving market direction and performance — ongoing concentration, tech dominance and speculative trading.

      As has been the case for the past nine months, we continue to see record levels of concentration, with just a few names dominating large-cap index performance. The five largest U.S. companies by market capitalization — namely, Apple, Amazon, Facebook, Microsoft and Google — now account for a record 21% of the S&P 500 and 36% of the Russell 1000® Growth.

      From a macro perspective, this means these indexes — and investors in these indexes — have never been more reliant on the performance of a handful of index constituents or vulnerable to an idiosyncratic shock to any of these stocks. In turn, when we see this level of concentration, we also believe there are significant opportunities for active managers to generate alpha — if they are willing to deviate from index exposures.

      Tech dominates

      My second observation is that the technology sector has really changed the makeup of the benchmarks. With the June 2020 reconstitution of the Russell 1000 Growth, the technology sector now accounts for 44% of that index. As you may recall, a big part of the recently formed communication services sector came from the tech sector, including Google, Facebook, Netflix and others. If those names are added back into the technology sector, it would then represent more than 50% of the Russell 1000 Growth Index.

      For context, the only other time the tech sector has represented such a large index portion was for a few short months during the 2000 tech bubble — and we all know the disastrous consequences there. Again, we think market extremes often create openings for active managers who seek to create well-diversified portfolios and are comfortable with positions outside the benchmarks.

      Meme momentum

      Finally, today it seems everyone wants to talk about the rise of retail traders like Robinhood, special purpose acquisition companies (SPACs) and cryptocurrencies. Clearly, we've seen individuals create speculative, casino-type action in the market, with little regard for a company's fundamental strength and earnings. In our view, it's very similar to the tech bubble and day trading craze of 1999-2000, and indicative of a market top. Ultimately, we don't think this type of trading is very relevant for those managers with an active, disciplined investment approach.

      Our strategies invest strictly in high-quality stocks and have high active shares. Higher-quality companies typically have consistent earnings, strong balance sheets, significant free-cash-flow generation, growing revenues and meaningful competitive advantages, whereas the opposite is generally true for their lower-quality counterparts.

      We don't know when these trends may reverse, but we believe that exposure to high-quality companies is more important than ever, as market imbalances and speculative excesses are seemingly continuing to build.

      Bottom line: With overconcentration and speculation driving the large-cap equity market, we think it's an opportune time for investors to considering allocating to an active, high-quality strategy — one that seeks to protect capital during declines, while still participating in the long-term benefits of equity investing.

      Russell 1000® Growth Index is an unmanaged index of U.S. large-cap growth stocks.

      S&P 500® is an unmanaged index of large-cap stocks commonly used as a measure of U.S. stock market performance.