The Shift Toward Equal Weight Stock Baskets in 2023

In the investment landscape of 2023, a notable trend has been the outperformance of technology giants, often referred to as the 'Magnificent 7.' These titans of industry have dominated market-cap weighted indexes, but there’s an emerging shift in momentum that could herald a revival for equal weight baskets, where smaller cap stocks can shine.

The Dominance of Mega-Cap Tech Stocks

Throughout 2023, a select group of mega-cap tech stocks with colossal market valuations influenced the trajectory of the broader indices. This select group, amassed more wealth than many nations and attracted significant institutional investments. As a result, these stocks overshadowed the performance of their smaller counterparts, making market-cap weighted indexes seem more robust than they were when considering the broader market performance.

Understanding Equal Weight Indexes

While market-cap weighted ETFs weight stocks according to their market capitalization, leading to a concentration of influence among larger companies, equal weight ETFs take a different approach. Each stock, regardless of size, has an identical weight, thereby ensuring a level playing field that highlights the value of smaller cap stocks.

Comparing Index Performances

The difference between market-cap weighted and equal weight performance is stark. For instance, the Nasdaq 100 Equal Weighted Index saw a year’s increase of 27.69%, in contrast to the standard Nasdaq 100 ETF which surged by approximately 50%. This trend was also evident in the S&P 500, where the Invesco S&P 500 Equal Weight ETF rose 7.65%, whereas the conventional S&P 500 Index ETF doubled that with an upswing of 21.31%. Despite this, signs are showing that the reign of mega-cap stocks may be winding down.

Signals of a Shift in Momentum

Changes in relative strength, where equal weight indexes outpace their market-cap weighted counterparts, suggest a pendulum swing. This is complemented by a rotation of funds into mid-cap and small-cap stocks, as mega-caps plateau. Additionally, historical trends indicate that when large caps become overextended, small caps typically come forward to lead the charge.

Moreover, a broadening of participation across the market is evident, with signs that investors are decentralizing from the 'Magnificent 7' and exploring a wider range of stocks. Lastly, the valuation gap is shrinking, as previously overvalued growth stocks see their price-to-sales ratios drop to inviting levels, stimulating investor interest.

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