With little fanfare last year, the S&P 500, the ubiquitous and mostly large-cap benchmark for U.S. stocks, topped 20% for a
record fourth-consecutive year. Few noted the milestone because the S&P's 21% return, nearly double its historical average, seemed like small potatoes next to the more tech-laden
Nasdaq Composite's 85.6% gain and the average tech fund's jaw-dropping 135% run-up.
But this year, the big-cap tech stocks that propelled the index have been weighing it down, and the streak is poised to end -- since Jan. 1, the index is down more than 4%. Investors with index funds or tech-heavy portfolios are duly rattled, but some observers say the downturn is just an expected cooling that illustrates much-needed breadth beyond the tech sector.
Because the index is weighted by
market cap and tech stocks have been leading the market over the past couple of years, tech has become the biggest sector in the index by far, and its leader. Barring a steep fourth-quarter run-up in sagging tech bellwethers like
-- which are both underwater and combined account for some nearly 5% of the index -- the index's 20%-plus streak looks to be over.
The Streak's End?
Source: Morningstar and Baseline.
"All those people who've been ridiculed for advocating diversification are vindicated a bit," says
senior fund analyst Scott Cooley. "If you pull out those tech stocks, the rest of the market is up. The S&P 500 is just a bit down, but the Nasdaq is down more than 17%."
And he might be right to point the finger at tech. Among the five sectors with the biggest representation -- which combined total roughly 75% of the index -- tech is far and away the biggest loser. Lower-octane sectors like financials and capital goods -- usually the hunting grounds of value investors -- have lapped tech.
Though the index is underwater, 248 of its 500 stocks are in the black since Jan. 1, according to
"I think in the last year or two, we've heard people talk about stealth bear markets because tech stocks kept the index up while so many stocks were down. This year has been a stealth bull market because so many other indexes are up," says Cooley.
Indeed, small- and mid-cap stocks are comfortably in the black this year.
Of course, a problem for tech stocks might easily bleed into other sectors. The tech slowdown could be signs of broader economic slowing and the threat of a recession.
"Tech is slowing down, but that's symptomatic of a slowing economy. Companies are having trouble meeting their profit expectations," says Phil Edwards, a managing director at
Standard & Poor's
funds unit. "I don't want to use the 'R' word
recession, but slowing economic growth would slow demand."
Even if the trouble is local to the tech sector, that's probably little solace to many fund investors. Flows to tech funds have set records over the past 18 months, and the average growth fund has sunk more than 40% of its assets into tech stocks.
As the index's returns have dipped this year, flows to S&P 500 index funds have slowed. Investors have shifted that money to actively managed stock funds, most of which are beating the index. Most active managers had little to boast about until this year. The average actively managed large-cap stock fund trailed the S&P 500 in eight of the past 10 calendar years, according to Morningstar.
Still, it's not a foregone conclusion that active managers are beating the index this year. Bill Miller, manager of
Legg Mason Value Trust, the only fund manager to beat the S&P 500 in each of the past nine years, narrowly trailed the benchmark through Monday's close. For many investors it might make sense to own actively managed funds, as well as index funds, rather than choose one over the other.
"Over the past 10 years the S&P outperformed 64% of actively managed large-cap funds, but through the end of August the S&P only beat 38% of those funds. A year like this shows you that there are times when it makes sense to have a portion of your portfolio in actively managed funds," says Bryan Olson, director at
Center for Investment Research.
In general, he thinks this year's losses might be healthy after last year's tech obsession.
"The breadth is a lot better, and the winners are more spread out this year. Also, small- and mid-cap value stocks are doing a lot better," Olson says.
This year might also painfully reinforce the advantages of diversification. Investors have been stock-happy for several years, but this year's volatility and modest returns could convince them to add bonds back to their menus.
"Once the returns are in at the end of the year, investors will see fixed income funds have a place in their portfolios. There's going to be an interest there for the first time in years," says Philadelphia-based fund consultant Burt Greenwald. "Over the last couple of years a lot of investors had the sensation of driving a Ferrari. They felt comfortable going fast, but now they're starting to think maybe a Volvo is safer."
The average taxable bond fund is up 3.7% so far this year, compared with 2% for the average U.S. stock fund, according to Morningstar.