S&P Equal Weight vs. Cap Weight

Oct 23, 2024

The rise of the “mega-caps” in recent years has caused a significant divergence in the performance of the S&P 500 — which is market cap weighted — and the S&P 500 Equal Weight index.  As the mega-caps like  Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), Meta (META), Microsoft (MSFT), and NVIDIA (NVDA) have pushed ever higher into multi-trillion dollar companies, their weight in the S&P 500 has ballooned to more than 25% of the index.  In the S&P 500 Equal Weight index, however, where each of the 500 stocks has a 0.2% weighting after quarterly re-balancing, the six mega-caps make up just 1.2% of the index.  Given these differences, it’s easy to see how the performance between a cap-weighted and equal-weighted index can diverge.

As shown below, the cap-weighted S&P 500 has posted a total return of just over 110% over the last five years compared to a gain of roughly 84% for the S&P 500 Equal Weight index.  As you can see in the chart, the gap between the two didn’t really start widening until early on during this bull market in early 2023.

Anecdotally, the cap-weighted version of the S&P 500 seems to be getting all the love these days, with some calling it the perfect momentum index.  Combining that recent sentiment with the very clear differences between the two indices, readers may be surprised that the longer-term performance between the two has been similar and even tilts towards the equal-weight version.

As shown below, over the last 20 years, the cap-weighted index has just recently overtaken the equal-weighted index on a total return basis, but outperformance has gone back and forth many times over this time frame.

And since 1990, the equal-weighted version of the S&P has actually been the clear winner over the cap-weighted version.

As you can see in the chart below, the Dot Com Bubble of the late 1990s pushed the cap-weighted S&P solidly above the equal-weighted version in the final years of that bubble, but the bursting of the bubble and the 2003-2007 bull market resulted in a performance shift that allowed the equal-weight index to pull ahead.  While the mega-caps of today have had a leg up on the rest of the market for the past few years, an extended period of underperformance from them would allow the equal-weighted version to become en-vogue again.

Below is a look at the differences in sector weightings for the S&P 500 (cap-weighted) and S&P 500 Equal Weight indices.  By default, the sectors with the largest number of stocks in the index will have the highest weightings in the equal-weight index.

While the Tech sector makes up nearly a third of the cap-weighted index, it’s only 13.7% of the equal-weight index.  Industrials and Financials each have a larger weight than Tech in the equal-weight index, while they combine for a weighting that’s just 2/3 of Tech’s weighting in the cap-weighted index.

When looking at the pie charts below, it’s the equal-weight version that appears more balanced and diversified at the moment.  No sector has a weighting below 4.4% in the equal-weight index, while the cap-weighted index has four sectors with weightings below 3.3%.  Movements in Materials, Real Estate, Utilities, and Energy have virtually no impact on the cap-weighted index as a whole these days.

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Breadth Bombs

Oct 24, 2023

A frequent point of discussion this year has been breadth, or more specifically, the massive impact of mega caps on the market-cap-weighted S&P 500’s year-to-date performance (something we discussed in yesterday’s update of our Sector Weightings report). We often use the 10-day advance-decline (A/D) line to measure how breadth is evolving in the near term; highlighting these readings for the S&P 500 and its eleven sectors daily in the Sector Snapshot.  This indicator essentially shows the average net percentage of daily advancers versus decliners in an index over a two-week period.

In the chart below, we show the S&P 500’s 10-day A/D line (expressed as standard deviations to clarify overbought/oversold levels) over the past year. The past week has seen a monumental shift in breadth. Just one week ago, the 10-day A/D line was deeply overbought sitting 1.72 standard deviations above the historical average, but as of yesterday’s close, it has fallen all the way into oversold territory; a 2.9 standard deviation drop in only four days.

Looking back to the start of our data in 1990, that is one of the largest four-day declines on record. In fact, the last time the line fell by such a degree or more was in September 2022 when there was a record decline.

While two-standard deviation declines have been uncommon, even fewer have resulted in the 10-day A/D line going from overbought to oversold.  In the table below, we highlight those nine prior instances that have occurred with at least 3 months having passed since the last occurrence.  The current period holds one of the higher starting readings in the 10-day A/D line. In fact, only November 2011 saw a higher reading.

As for S&P 500 performance going forward, returns have generally been mixed.  One week after big ‘breadth bombs’ the index has actually risen better than three-quarters of the time, however, one month out has averaged a decline with positive returns less than half the time.  Three months out to one year on have all averaged positive returns, but those are all weaker than the norm.