"The S&P 500 Isn’t as Diverse as It Used to Be. Here’s Why That Matters." - Derek Horstmeyer

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In this article, Derek Horstmeyer informs readers about the increased volatility and interest-rate sensitivity that has come with the dominance of tech and financial stocks in the S&P 500. Horstmeyer describes that while many investors hold index funds because they believe it is a risk-free and diversified way to follow market fluctuations, they are unaware of the assets inside of the funds and the possible risk behind it. 

To analyze the recent changes and the implications behind them, Horstmeyer and other research assistants collected data on the S&P 500 over the past 50 years. They examined how different components of the index changed through the years such as interest-rate sensitivity, dividend yield and volatility. After the study, the researchers found that the S&P 500 has become significantly more concentrated in technology and financial stocks with higher sensitivity to interest rates and more correlation with other indexes worldwide. More specifically, they focused on how the composition of the S&P 500 has changed over time and concluded that industrials and materials lowered from 26% to 10.6% while information tech and financials increased from 13% to 42% since the 1970s. They even found that six of the top seven positions that make up the S&P 500 are in the tech sector, which compromises about 29% of the index. Ultimately, these results only epitomize how holding the S&P 500 has a similar level of risk as holding tech firms directly, especially with interest-rate risk, high price valuations, and optimistic growth-rate expectations. In other words, this major stock index has become less diversified through the years due to the domination of technology and financial stocks and has also become more correlated with global markets. 

Horstmeyer also explains how sensitive the U.S. stock market has become to interest rates by using statistics from the average Shiller CAPE price-to-earnings ratio which was 13.5 in the 1970s and 30 by the early 2020s. Moreover, he also describes how the S&P 500 went down by 20% in 2022 when the Federal Reserve raised interest rates by 5%, which just shows how volatile the expectations for earnings growth currently are. The S&P 500's dividend yield has also significantly decreased from 4.11% in the 1970s to 1.45% in the 2020s, which is another clear indication of the increased volatility of stocks that brings more risk for investors and challenges the traditional diverse and low-risk view of one of the major stocks indexes. Lastly, Horstmeyer highlights the increased correlation between the S&P 500 and other famous world stock-market indexes. In fact, the average correlation jumped from 0.24 in the 1970s to 0.70 in the early 2020s suggesting how returns in other parts of the world match those in the S&P. This worldwide correlation has major consequences because it reduces the diversification an investor has even if they incorporate some world indexes to the U.S. holdings. Thus, it is much harder to reduce the volatility and risk in a portfolio by adding stock-market indexes from other countries since they are too closely correlated with the S&P 500's holdings. Horstmeyer concludes the article by recommending investors who seek diversification in their portfolios to be creative and include other investments such as commodities, alternative assets and other uncorrelated asset classes.

This article is strongly related to what we discussed in class about the relevance of index funds such as the S&P 500, however it manages to bring a new perspective about the diversification and composition of such indexes. Horstmeyer challenges the traditional view that index funds are highly diversified and low-risk and makes readers reconsider what an investment in indexes like the S&P really means. Furthermore, many of the concepts Horstmeyer used to back his argument were also explained in class such as dividend yield which is the relationship between the dividend and the stock price. The point he brought up about increased correlation of the S&P 500 with other worldwide stock-market indexes was completely relevant from my perspective as it demonstrates how the solution to attaining diversification in a portfolio is not as simple as adding international stocks. In class, we emphasized how owning shares of the S&P 500 is not enough to have a diversified portfolio, however Horstmeyer is able to build on this even more by illustrating how owning international stocks in addition to indexes like the S&P is also not enough to attain diversification. 

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Works Cited

Horstmeyer, Derek. “The S&P 500 Is Heavily Weighted with Tech, Financial Stocks. Here’s Why  That Matters. - WSJ.” The S&P 500 Isn’t as Diverse as It Used to Be. Here’s Why That Matters., Dow Jones & Company, 3 July 2024, www.wsj.com/finance/stocks/sp-500-tech-financial-stocks-weight-62ed530a. Accessed 04 July 2024.