The High-Flyers: Where Are They Now?

In the past six months, we’ve witnessed a remarkable rally in several stocks, especially those connected to the field of artificial intelligence (AI). Astonishingly, some of these stocks have seen returns exceeding 180% in an incredibly short time frame. Below, we present the top 10 stocks in the S&P 500, ranked by market capitalization weight. We’ll provide their previous 1, 3, and 5-year returns, along with their year-to-date performance through June 2023:

Many investors have been enticed by these surging returns, leading them to invest in these stocks with high hopes of the surge persisting. Nevertheless, it’s imperative to recognize that the majority of these stocks are currently trading at their highest-ever prices, accompanied by valuations that seem precarious. Just a few years ago, the concept of trillion-dollar companies was virtually unheard of, yet today we have several of them. Take Apple and Microsoft, for example, which hold the top two spots in terms of market capitalization, with each nearing the three-trillion-dollar mark, surpassing the entire value of the German stock market. It’s worth noting that Germany boasts the fourth largest GDP in the world. This surge in valuation, while these companies undoubtedly maintain their dominance in their respective industries, appears to be somewhat detached from reality.

As the saying goes, history doesn’t always repeat itself, but it often rhymes. The chart below demonstrates that high-flying stocks tend to perform exceptionally well in the 3, 5, and 10 years before they become the largest companies. However, once they reach the pinnacle, their returns tend to lag significantly. There are a couple of reasons for this. First, stretched valuations take years for earnings to catch up with stock prices. Second, it becomes exceedingly challenging to grow further when you are already a massive corporation.

This pattern isn’t new. During the dot-com era, we observed a similar phenomenon.

The chart above illustrates the extraordinary performance of the top stocks during that era and what happened to their stock prices when they peaked. Among the top 10 stocks, six had negative returns from their peak in 2000 until June 2023. Even Microsoft, which fared well, remained stagnant for almost 15 years after reaching its peak in 2000.

We’ve previously discussed the S&P 500’s composition, with these high-fliers now accounting for 25% of the index, an all-time high. Remarkably, 95% of the index’s returns have come from these companies. While it may seem sustainable, historical trends and valuations suggest otherwise. The chart above also illustrates that a broadly diversified investment would have outperformed the top 10 companies of the 2000 era. We’re likely to see this again, but we can only confirm it after it’s happened.

So, what should investors do? While these companies are already part of our portfolio, it’s equally crucial to maintain positions in other companies that have the potential to emerge as the top 10 performers of the future. Diversification isn’t synonymous with reduced returns; instead, it signifies the potential for greater returns while mitigating the risk of heightened volatility. This is the core principle of diversification.

Undoubtedly, investor sentiment has experienced weariness following the market decline in 2020 due to the COVID-19 pandemic, and another dip in 2022 brought about by inflation, geopolitical tensions such as Ukraine, and various other factors. It’s crucial to keep in mind that your stock allocation is designed for the long term, potentially spanning decades into the future. The current volatility we’re experiencing will likely fade into insignificance, much like previous market fluctuations that eventually rebounded.

As depicted in the chart below, historical data indicates that market returns tend to exhibit strength in the years following a decline, whether it’s one year, three years, or five years down the line. Achieving these returns necessitates patience and a steadfast commitment to staying the course, even in the face of uncertainty.

We appreciate your trust and patience. We’re here to address your questions and provide insight into your goals and how your hard-earned money is being invested. Please reach out to your Bluerock Team with any questions.