Index Weight-Watching in 2018

We’re starting the New Year with some weight watching, but targeted at popular global investment indices rather than waistbands. The key issue: as we kick off 2018, where are investors (perhaps unintentionally) overexposed to Technology? And where are they underweighted? We cover this important theme regularly, but with the turn of the calendar it is a good time to provide you with an update.

To get a sense of what an “Appropriate” Technology weighting might be for a global equity portfolio, consider the industry allocations for two popular market measures:

• Technology represents 16% of the MSCI World Index. The sector sits in between Financials (at 18%, the largest sector weighting) and Heath Care (12%, and in third position). Importantly, this index does not include Emerging Markets.

• In the FTSE Global All Cap Index, Technology has a 17% weighting. As with MSCI World, Financials are the largest sector (19%) but Consumer Cyclicals are in the third spot with 12%. Unlike MSCI World, this index does include Emerging Markets.

Based on these two measures, we can say that a 16-17% weighting to Technology is something like a “Normal” allocation, since it approximates the aggregate market cap for the sector globally as a percentage of all listed stocks.

Now, here’s how a variety of common market indices compare:

1) The S&P 500 is 23% Technology. The top 5 Tech names represent 13.4% of the entire index: Apple (3.8%), Microsoft (2.9%), Google (2.8%), Amazon (2.1%), and Facebook (1.8%).

2) MSCI Emerging Markets are 28% Technology. The Top 5 Tech names are 18.0% of the whole index: Tencent (5.4%), Samsung (4.3%), Alibaba (3.6%), Taiwan Semi (3.5%), and Baidu (1.2%).

Bottom line on these 2: since neither index has an upper bound on stock/sector weightings, global Tech leaders logically dominate at 13-18% of each. That is a dramatic departure from other widely followed indices, which we will outline next.

3) The Dow Jones Industrial Average holds 17% in Technology. The holdings by name are: Apple (4.7%), IBM (4.3%), Visa (3.2%), Microsoft (2.4%), Intel (1.3%) and Cisco (1.1%).

4) The S&P 400 Mid Caps hold 17% in Technology. The Top 5 Tech names are 3% of this index: Take Two Interactive (0.7%), Broadridge Financial (0.6%), Cognex (0.6%), Trimble (0.6%) and CDK Global (0.5%).

5) The S&P 600 Small Caps hold 14% in Technology. The top 5 Tech names are 2% of the entire index: CACI Intl (0.4%), Stamps.com (0.4%), Rogers Corp (0.4%), Lumentum (0.4%), Advanced Energy (0.3%2

6) The Russell 2000 Small Caps hold 16% in Technology. The top 5 Tech names here are just 1% of the entire index: GrubHub (0.3%) EPAM Systems (0.3%), MKS Instruments (0.2%), Aspen Technology (0.2%) and Fair Isaac (0.2%).

Bottom line on these 4: on the plus side, they all closely mirror the global weighting of 16-17% Technology instead of going all-in like the S&P 500 or MSCI Emerging Markets. The downside on the Dow: no Google/Facebook/Amazon, and little chance for inclusion given their high nominal prices. As for the Mid/Small Caps: how will “Small Tech” perform when “Big Tech” continues to dominate?

7) The MSCI EAFE (Developed non-US Economies) Index is just 6% Technology. The Top 5 Tech names are just 2% of the index: SAP (0.7%), ASML (0.5%), Keyence (0.3%), NXP Semi (0.3%), and Nintendo (0.3%).

Bottom line here: This one worries us. In a world dominated by technological disruption, it seems unwise to own so little of this powerful macro trend. In fairness, that is not the index’s fault, per se. Europe and Japan has simply lagged in developing world-class technology companies. But the chance they can catch up seems remote.

In summary, while investors commonly lump their options into geographic or market capitalization buckets, this misses the important factor of Technology weightings. As we’ve shown, those vary widely and given the group’s +1.0 beta that will inform a large piece of the performance equation in 2018. Our fundamental stance is to favor global super-cap technology for its disruptive impact on existing industries and consumer/social trends. That gives the nod to the S&P 500 over other US equity indices, and Emerging Markets over EAFE.