The major capitalization-weighted stock indices have produced return figures so plagued by statistical aberrations that one is tempted to question their value as market barometers. Investors who for whatever reason failed to embrace the biggest stocks or most popular sectors were very unlikely to do as well as the averages suggested was possible. Despairing of such results, many clients repaired to the apparent safety of index funds, and at least one filed a lawsuit. We thought it would be constructive to examine the phenomenon from a longer-term perspective, focusing on the problem with big stocks and their impact on the indexes, the investment business, and the investing public.
Unweighted returns are a simple average of the returns of all stocks in the index.
They are themselves not free of distortions of their own, since outsized moves by a few stocks can unduly influence the average. Be that as it may, when viewed alongside the value-weighted figures, the simple average gives us some idea of the skewness of the former, due to the impact of the biggest stocks, that is not readily ascertainable in those results alone. Graph I, which includes the period of the current bull market, confirms that this has truly been a great time for the big stocks, relative to the broader market. Nothing new or surprising so far. However, Graph II, which merely extends Graph I a decade further into the past, may call into question the wisdom of extrapolating into the future even stable-appearing trends.