Talk Your Book: Investing in a Concentrated Stock Market

0:00Today's Animal Spirits Talk Your Book is brought to you by State Street. Go to State Street. dot com slash investment management to learn about the original ETF, SPY. That's state street dot com backslash investment management to learn more. Welcome to Animal Spirits, a show about markets, life and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:37Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:46Welcome to Animal Spirits with Michael and Ben. Man, it's crazy. I remember in 1993 when SPY was launched like it was yesterday. You know what I mean? I feel like time is moving so fast, Ben. Actually, I saw the original ETF in the theater. You know what? My Canadian brethren always remind me that SPY was the original US ETF. There was actually an ETF in Canada that came up before this. They didn't know that. No, that's good intel. But yeah, this is, SPY is a brand. And there's so much to talk about with the stock market these days. And it's because of the concentration and AI and the other 493 versus the Mag7.

1:24So we ended all that with returning guest, probably one of our, I think one of our guests who's returned the most on the show, probably he's been on, I don't know, six or seven times now, Matt Bartolini is a managing director. One of our favorites. Yeah. He's the managing director at State Street Global Advisors, head of Spider America's Research. We've talked to him a bunch. He's, he's great. So here's our talk with Matt Bartolini.

1:50Matt, how are you? Good to see you. My bald brother. Yeah. Yeah. Good to see you too. The follically challenged. All right. Yesterday I was talking with Josh and I shared a chart and on the top pane of the chart showed the Mag 7 divided by the S &P 493. And that ratio is breaking down. Simultaneously, I showed on the bottom pane, the Russell 2000 versus the S &P, and that is breaking out. It's a really interesting market that we're living in. We're recording this on January 21st. And I said to Josh, is this bearish or bullish? And I think we both thought the latter, that the 493 taking the baton is like, listen, if the MAG7 crashes, I think we're all in trouble, obviously, given the concentration, which we'll talk about.

2:38But let's just say absent a MAG7 meltdown, the 493 looking better, is that a bad thing or is that a good thing? What do we think? So I think it's bullish for the economy, right? So it sort of signifies that the sort of market returns are broadening out and that it's not going to be so concentrated, even though we still have rampant concentration. I think one of the more instructive things probably within that chart, which I can sort of visually think about, is that breakout of small caps. And that breakout of small caps really is coincided with monetary and fiscal policy impulses benefiting them.

3:12So whether it is lower rates, lessening the cost of money, small caps tend to be highly indebted, or the One Big Beautiful Bill Act and the changes to expense reductions that take place, R &D expensing, and just the benefit to the consumer. And if you're more consumer-oriented, which small caps are, that can be beneficial. And we've seen earnings be revised to the upside for small caps. Same with large caps, but small caps now have double-digit earnings growth forecasted for 2026. And since the end of July, which we started to see the Fed signal more accommodative monetary policy, cut rates as well, that fiscal impulse of the legislation, small caps have up for large caps by 13%.

3:51So you started to see that breakout. So I'd say that's bullish for the broader economy where you're not just having seven, six stocks driving all of the market action. Do you guys have to update your definitions of small, mid, and large? How often do you have to update that? Because it has to be a moving target, obviously, right? Yeah, it's sort of theoretical to some degree. Whatever benchmark you want to use, is it the Russell 2000s, is it the S &P 600? What is the actual band that you do have within that small and mid-cap space? if you have in the S &P 400, which is mid-cap, the 401st security, I don't know what it is, we can say the average market capitalization, say it's 15 billion.

4:33Well, just because of the numerical math of Ewing can have 400 stocks, it gets bumped down to small caps. And it's actually, it's market capitalization maybe under a Russell definition would be in the large cap or it would be under crisp definition in the small caps. And so like when we have these discussions, we think about having similar benchmarks to decompose your cap structures. So you have no gaps and overlaps. So, you know, S &P 500, so a spy. Then if you're using the Russell 2000, what have you done? Mathematically, you've cut out the middle. So if you want mid caps, you could probably have the 400.

5:05So yeah, the definitions keep changing because they have those more fixed bands. I asked Ben on Animal Spirits this week, we're talking about the market in between our movie conversations. And so I think the current backdrop coming into the year, it's hard to argue that the economic financial slash financial conditions are anything but accommodative. We have inflation for the most part going in the right direction. You have rates commensurately coming down. You have the AI CapEx spend, the tailwinds there. The economy is doing fine. There's no credit delinquencies. frequencies, like things are good.

5:48And then on the other hand, you say, yeah, but like everybody knows it's good. The market's been pretty good. Was it three, we had two 20 % up years and then a set up 17 % a year. Like the equity gains have been commensurately good. So I think when people start talking like about on the one hand and the other hand, I think we could outthink ourselves and try and get a little bit too cute. Like, oh, everyone knows that everything is good and therefore, like I should maybe go the other way. I don't know. Maybe sometimes that works, but by and large, is that how you see it? Like the conditions for continued stock market appreciation, which with the obvious caveats that who knows what is going to happen with the future, whether it's the tariffs or anything else that comes out of nowhere, like absent that aside, it's never going to be a straight line up.

6:34But generally speaking, like we're in a pretty Goldilocks sort of environment. Did I just say the G word? But we are. Yeah, I mean, I think you always have to think of what the catalyst might be, which is always really hard to forecast. And I think that's why it's the game of markets. And when we look at it, so growth on balance is improving, right? So if you look at the GDP now print from a couple weeks ago, it was over 5%. We're not going to be at that level, but growth on balance on an aggregate basis across the globe continues to ring positively. The same token, your monetary policies over the last 18 months have been more accommodative than not.

7:09You've seen rate cuts from major central banks. Many of them are probably on hold for the next foreseeable future over the next year. But those rate cuts still have to make their way into the economy. So the sort of cost of money is getting cheaper. If you look at money supply around the globe, it is moving higher. So there's more liquidity in the marketplace. That is beneficial. I think there are, that doesn't mean there aren't risk. I think, I do think there's an inflation upside bias risk due to some of these policies where you might be overheating. but you don't have this catalyst to sort of pop any excitement just yet because even though markets are up double digits and massive concentration this is not the dot-com era where you have these market returns but earnings are declining earnings are growing you see really strong earnings growth from the u.s on a global basis as well emerging markets are forecasted to have higher earnings per share growth in 2026 than u.s equities so on balance the market environment appears quite healthy, which despite all of the headlines, right?

8:10So you're talking about movies, right? One battle after another. This is like one headline after another to impact sentiment. To impact sentiment. It's so hard. You get all these questions. Oh, should I be concerned about this? I saw like, we're going to take over this country or we went into this country or doesn't this look like the movie Sicario? And you start to think about it and you're like, it's fine. Assets over time outperform cash. Holding assets is a good thing. Being diversified is even a better thing. So we asked you in the past about the flows. So we're starting to see, like Michael said, the 493 kick up a little bit, small caps maybe making some noise.

8:43Internationally, emerging market stocks had a good year last year. Is any of that showing up in the flows yet, or is all the money still just going into large cap U.S. stocks? So the majority of it's still going into U.S. large cap, but that's a big market. So last year, I think it was something to the effect of 74 % of all flows into equity ETFs in the U.S., U.S. listed, went into U.S. equity exposures, like a SPY, for example. Is that higher than normal or is that about what it is? So that's the thing. That's high. That number sounds big and it is big, but it's below what their market share would indicate.

9:16So their market, U.S. equity ETFs, market share of equity ETFs is 80%. So on a relative basis, while that money is huge, it is less than their market share would indicate, and it's far less than what we saw in 2024, where they took in 86%. So there is a broadening of geographical diversification, where you see it going into those developed markets, into emerging markets. And to some extent, it makes sense. If you look at last year's return patterns, and you look at all the non-U.S. equity markets in the MSCI ACQUA, 76 % of them beat the U.S. That's the largest hit rate since 2009. And the average excess return was also the largest since 2009.

9:57And it coincides with this reworking of the macroeconomic paradigm, which is supporting broader regional diversification away from the winningest trade over the last 15 years of U.S. equities. I'm sure you get this question all the time, SPI being the OG of S &P 500 ETFs. The concentration persistence. I think people wonder, like, well, what happens if it stops working? What happens if it like worsens and stops working? What happens if it unravels? You can't talk about these companies without looking at the fundamentals. It's like, oh, they're 35 % of the index. Okay. What about the percent of the earnings?

10:40I mean, I know the market cap percentage is higher, but it's not like it's 35 and the earnings are only 9%, right? Like the gap is not that large. is that a concern um from your end or is this what a normal healthy function bull market looks like and we've been discussing this is not a new phenomenon i think fangs were coined in 2017 like it's been it's been almost a decade we're having the same conversation yeah so i think concentration has always been in the markets to some degree even if you look at non-us markets so you know spain very concentrated at the top uh south korea very concentrated at the top obviously different countries.

11:17The U.S. is far bigger than those two. So market concentration is not a new phenomenon. And here in the U.S., we've had concentrated markets well before. I think right now in terms of like, is this a concern? Well, again, these firms are big for a reason. They sell a lot of goods and wares and they're at the forefront of the AI productivity miracle. I mean, myself, I've probably interacted with four of the companies and their devices and services probably within the last hour just because I have an iPhone, I have a Gmail account. Those are the things that I'm just ingrained with. I think we renewed our Netflix subscription.

11:48These are just things people do on a day-over-day basis. I don't think I'm that unique from that perspective. I think one of the things that's hard, though, is are these always going to be the same top seven, top 10, whatever companies? And I think that's where that is a hard thing to forecast, but it's probably likely that they're not going to be the same because history often repeats itself. where if you look back over the last 15 years, at one point, Exxon was the world's biggest. It would be hard to fathom at that point that Exxon could no longer be the biggest company in the world because look how much oil is coming out of the ground.

12:20Or GE or IBM. If you went and asked my parents or my grandparents if they were still alive, like GE is no longer the largest company in the S &P 500. They'd be like, what happened? And I think that's the same sort of cultural resonance. The connection was made to football, right? Football is the most popular sport in America right now. But if you went back to the 1950s and told people that horse racing and boxing was no longer that important, it would break their brain. And right now, it's the same thing. Something's going to have to happen where those companies are no longer as big as they are now.

12:52And it's likely regulatory, antitrust. Are all their AI capabilities just going to be unloaded into their goods and services so you don't have a choice? Or does AI become too commoditized? So concentration is not a problem, but it's going to change over time. But you should still maintain investment into broad assets. You have this interesting piece on concentration, and you're looking at it from a dividend yield perspective. And I know people have used that as a valuation framework, like in the dot-com bubble. Like the dividend yield got so low. People said, this is showing stocks were valued.

13:26And if you use that framework today, it doesn't work as well. And you make the point that a lot of it is changes in sectors. So you said, and you looked at it in 1990, energy and industrials and consumer staples made up, it looks like almost 45 % of the total. And today, I think that number is probably more like, I don't know, 25%, 20 % for those. Energy is down to like 3 % of the total. And you're saying those are higher yielding segments of the market. And utilities is, I don't know, only 2 % of the market. It's a much smaller allocation for these sectors, not just stocks, but sectors that don't comprise as big of a weight.

13:58And the ones that are more concentrated, they're doing buybacks. So you can't really look at dividend yield as this valuation framework anymore because you're still getting that same kind of thing through buybacks. It's just you don't see it in the form of a yield. Yeah. Dividend yield is really not a great metric to utilize for valuation anymore because a lot of these companies don't pay dividends. And the biggest companies where their contribution to the dividend, they don't pay either a sizable dividend or don't pay any dividends at all. and this idea of owning equities for income as an income-producing asset is gone.

14:33Like it's not, they're not income-producing assets. You know, they generate negative real income. If you look at the dividend yield on the S &P 500, it's 1.12%, I think, today. It's well below the rate of inflation, well below the rate of cash. So wait, has it ever gone under 1 % before? Probably not, right? No, the lowest is like 1.08, I think. So we're like, but we're like - So if that happens, people are going to make a big deal about it probably. But that was in what, the dot-com bubble? Yeah, I do have the chart up because it was obviously something they wrote about. 1.1. Man, that is really, it's so low.

15:07It's extremely low. And like the contribution of returns from income, it's extremely low too. Yeah. But to your point, you show the chart in here of, yeah, the dividends by sector, but then you show buybacks and that is increasing and that gives you a similar effect to dividends. And oh, by the way, it's more tax efficient for investors too. Yeah. And that's why like whether the sector makeup changes where these, you know, low income producing sectors all of a sudden are no longer the biggest like tech communication services, it's not going to change because the way companies are returning shareholder value is massively changed.

15:40That's why shareholder yield is so important. That's probably a far better metric for assessing valuations and dividend yields. It assumes buybacks, but there's been massive shift of doing buybacks more than dividend than paying dividends by companies, and that has reduced the amount of income generation available to common U.S. equities, which means for income-oriented investors, which they're only getting more of them as the demographics shift and skew older, they're going to need to find different sources of income. And in order to do that, you're going to have to modify your asset allocation mix and maybe take on some biases towards credit, towards value stocks, dividend equities or value stocks, or using some sort of asymmetric type return profile, derivative income, things like that.

16:24You're going to do something differently. You can't just own the S &P 500 for income. I mean, I know you remember how often this would come up, not just in financial circles, but in the Venn diagram of politics and investing, the buyback issue, and how it was just used to goose earnings or offset share issuance or whatever. I'm very happy that we don't have to have that tired debate anymore. There's no question here. Do you guys remember that? Yeah. Why did that die? Is this the Chris Farley show? Yeah, yeah. Remember that? That was cool. Do you remember when you were in Wings? That was cool. But why do you guys think that died?

17:08I mean, that kind of did it. It was just so pointless, but that was a big thing. It became just super tired. It's like this idea of like active versus passive, which I know I just wrote an article about that, but took it more of a lens of like buying behavior and preference. But this idea of like active is better, passive is better. And it sort of became like people just use what they would like to use in portfolios based on their outcomes and preferences. And that's kind of how it works. Like, yeah, of course, one might be better than the other. But at some point, there's only so much juice you can get out of a certain debate.

17:34And I think the shareholder buyback one, it started to just lose its luster because ultimately, like, it wasn't that big of a risk. It wasn't that big of an issue. What do you think is the modern-day version of it? I kind of feel like – I feel like concentration is. Concentration? Yeah, that's true. But have you done any work – if you look at the shareholder yield to historical – if you include the dividend yield plus the share buybacks, it's probably pretty similar, isn't it? It can't be that far off from historical norms. I haven't looked at it in a while. We did this one big study because I remember when there was a big fervor on it of like someone said something about company stock volatility is exacerbated during the buyback blackout window because companies weren't buying back their stocks.

18:20And that was a result of all this volatility, which we disproved by looking at this analysis going back, you know, like 1990 or something. So that debate was still there. but to answer your question, not to go on that tangent, but it's probably similar because these companies are massively increasing their buybacks. If anything, I don't even see that many headlines now of like, you know, Apple approves$100 billion buyback. And that's the other thing too. There's like a signaling effect to it. They might've said they'll do$100 billion, but no one ever goes back and checks. I mean, someone do, some do, but like the broad media who maybe writes that article, they never go back and go, you know, Apple only did$80 billion.

18:56That doesn't seem like it's a good idea. Let me offer a, I think this is a contrarian take. In fact, it definitely is. I'm not naive to history, not to brag. I've read many books. I think it could be possible. It could possibly be different this time with the top 10 stocks. And in fact, it has been recently. We're seeing a slowdown in terms of turnover at the top 10. And I think the main difference, there's a few main differences between General Electric and IBM and AT &T and Exxon and Johnson & Johnson, whatever, versus the ones today. How often back in the day did people interact with General Electric?

19:38I know there was appliances and credit and all that sort of stuff, but these products are so ingrained in society and our every single day life. And the monopoly and the moat and the margin stability and expansion, in many cases, it really truly is. And this is not an opinion. It is unlike anything we have ever seen before. And I know that it was difficult to foresee what could displace IBM in the 60s and 70s. Nobody could have foreseen Microsoft. But also just the size of these companies and what they're doing to the startup community where there is only a size so big that these companies can get before they're just bought up and gobbled up by Google.

20:27These are venture companies in many cases. And so, yes, Anthropic is out there and OpenAI, and maybe those are the next things. And who knows? Obviously, I'm not an idiot. I'm not going to pound the table and say that Apple will never be outside the top 10. I'm not saying that. But I think that there is a real argument that we're still having the same conversation 10 years from now about Google and Amazon and Microsoft and Apple. Yeah. I mean, look, if I were to place odds on it, you know, two to one chance maybe, right, that something happens. It's hard to fathom that what is currently a reality will obviously change in the future, particularly for these very big, well-known companies.

21:03But like, GE is kind of as interesting analog, right? What did they own? They owned NBCUniversal. They were making movies and TV shows. They made dishwashers and refrigerators. They're also big into hydropower plants as well as jet engines. Like, they had their hands in many pots and started to divert away from their sort of core businesses. I don't think obviously that's the case right now, but you know, and look, Amazon's doing really well making movies, right. And same with Apple. They have some good TVs and movie shows, but at some point, like, are you just getting too big where you move away from your core services?

21:33I'm not saying any of them are now, but I think those are those like signposts. And again, like not that this was a big risk, but one of those signposts a little bit was when they tapped the debt markets for the first time to fund some of their AI initiatives. It's like, oh, hmm that's interesting i'm gonna i'm gonna kind of fly i'm gonna fly i'm gonna store that away i'm gonna flag that not a big risk but that's interesting they usually don't do that so totally agree it's hard to forecast the future is the big takeaway and you know i was asked this question of like well isn't you know spy if you just own spy you own ai like all these kind of like isn't that just a way to get ai exposure and it's like well you could do worse what's the central dominant market macroeconomic market theme right now it's ai if you were going back to the early 1900s, it's railroads and oil companies.

22:18That was at the top. So it's sort of a sign of the times. And it's not a bad thing you're buying these massive AI companies because they're making a lot of money. If they weren't, if it was the dot-com era where earnings were declining, that's that risk. Their earnings contribution - Well, listen, Spying Shell has been the best strategy for the last 15 years. Like, I can't even imagine what somebody would have had to do to outperform. Even last year, like, I think we – not a record number of stocks not beating the market. By the way, like this – I guess the active-passive debate is a very tiresome one.

22:51But it's no mystery why active has had a tough time. If you look under the hood, most stocks have not beaten the benchmark because the benchmark gains have been concentrated in the biggest stocks and the biggest winners. Like, it's no great mystery. and whether AI like fizzles out and whatever. And then there's something else like you're going to ride the ups and downs of innovation and you're going to, you're going to get capitalism. Like that's, that's spy. Yeah. And if we look at the returns last year and it's just one year, but these are instructive of prior years too, and the numbers will move around.

23:23But in spies category, us large cap blend, only 31 % of managers were able to beat their benchmark. The average excess return was minus 200 basis points. Oh, brutal. So like looking at the win loss record, like that's not a great record and be like, okay, well I'll just own, I'll just own spy. Like, I don't want to have to make that excess return choice. I want to own the asset. I want to own the asset. This is the year, man. I hope this is the year that like, I hope the last year was the bottom and it's not even bad for spy. Like, in fact, um, just, just let the four 93 have their, have their day in the sun.

23:56And like, it is such an interesting market. Like, uh, I think a lot of the AI trade is being rejected right now and it's not, and the market's, Doing just fine. Like Oracle is getting really beat up. Like new 52-week lows today. Microsoft is breaking down. And I guess that's probably the closest proxy to the AI trade. NVIDIA obviously too. But like investors are today rejecting the hype. And they're buying other things. And I think like – I think it's a breath of fresh air. I think I – you know, not I think. I do. I love it. I think it's wonderful. So it's great to see a broadening of market leadership.