The U.S. equity market has shifted to reflect changes in the economy.
The U.S. economy is constantly changing to reflect the behavior patterns of its participants, the changing global economy and regulatory structure, and shifts in demographics and technological innovation. Just as the composition of the economy and retail sales have changed over time, so has the composition of the U.S. equity market.
Over the two decades from September 1996 through August 2016, the total market value of the Standard & Poor’s Composite 1500 Index increased 243 percent, an annualized gain of 6.4 percent. Over the same period, nominal gross domestic product increased at a 4.2 percent rate, while real GDP posted 2.3 percent annualized gains.
Among the ten sectors of the index, information technology, health care, and financial stocks posted the largest gains, increasing in total market value by 526 percent, 356 percent, and 315 percent, respectively (Chart 5). The weakest performers were telecommunication services, up just 36 percent, and materials, up 83 percent.
The strong outperformance of the information technology, health care, and financials sectors reflects the growing importance and stronger underlying growth of the companies in these sectors. In each, the companies have generally benefited from strong sales and earnings growth as a result of increased demand. That increased demand has often been supported by some combination of technological innovation and demographic trends.
Indexes constructed with market-capitalization weightings rely on the collective wisdom of investors to determine sector allocations. As capital is allocated to some sectors rather than others, the total market value of sectors changes. Market-cap-weighted indexes reflect those changes over time.
Over the 20 years from 1996 through 2016 the value of each of the 10 economic sectors has grown at different rates. As a result, the composition of these indexes has changed. In 1996, financial stocks accounted for the largest market-value share in the S&P 1500, at 14.3 percent. Second was industrials at 13.6 percent, and rounding out the top three was the consumer discretionary sector at 13 percent. Combined, the top three sectors accounted for 41 percent of the market value of the index. By contrast, the bottom three sectors—utilities, telecommunication services, and materials—accounted for 17.1 percent (Chart 6).
As of August 2016, the largest market-value share within the S&P 1500 belonged to information technology, at 20.6 percent. Financials and health care were the next two largest sectors, with market shares of 17.3 percent and 14.2 percent, respectively. Combined, the top three sectors accounted for 52.1 percent of the total index, up 11 percentage points from 1996. By contrast, the bottom three, which were still telecommunication services, materials, and utilities, accounted for just 9.1 percent of the total index, a drop of eight percentage points. The net effect is that the S&P 1500 is now more heavily concentrated in the top three sectors than it was 20 years ago.
Market-capitalization-weighted indexes like the S&P 1500 are a popular and efficient tool for investing. However, investors still need to be aware of shifts in the composition of the indexes within their portfolios. Changes in index composition, even when driven by market performance, can alter the investment characteristics of an index over time.