It’s a bad sign if an index has too many large cap stocks from one sector, said Bill Smead, CEO and chief investment officer of Smead Capital Management.
“The excesses of this bull market are in the glam techs,” Smead said on CNBC’s “Closing Bell,” referring to names like Amazon, Tesla and Netflix.
Currently, 25 percent of the S&P 500 is composed of tech stocks and large cap stocks like Amazon and Netflix. His investment firm, based in Seattle, is the owner of long-duration common stocks.
“It was a danger signal for RCA stock in 1929, the Nifty Fifty stocks in the 1960s, oils in 1981, tech stocks in 1999 and banks in 2005,” he said.
Smead argued that in each era, the large concentration of stock in a particular sector helped propel the bull market, but was followed by a crash made significantly worse because of the losses.
“The next bear market will be centered around these glam stocks,” Smead said. “They’ll go from being glamorous disruptors to just disruptors.”
Despite the recent correction, Amazon and Netflix and other large-cap tech stocks are holding up way better than the average stock, Smead said. Amazon and Netflix have surged 26 and 46 percent so far in 2018, respectively. The S&P 500 has notched a 1 percent gain over the same period.
But lofty share prices means that investors could see substantial losses in the next bear market, Smead said.
“Regardless of when these stocks stop going up, when they break, they’ll crush people,” Smead said. “Everyone will get crucified in the next bear market and there will be nothing to stop the bleeding.”
David Ellison, portfolio manager of Hennessy Funds, pointed out that today’s big cap stocks were small caps just a short while ago. Legacy companies like GE or Ford matured slowly, unlike Amazon which rocketed to its current heavyweight status in a much shorter span of time.
“These are kind of new companies that are still being tested by the market,” he said.
But Smead said the current concentration of large-cap tech stocks in the indices is just testing fate.
“From a historical perspective, the major bear markets all punished the most successful stocks of the prior era. You’re betting that a shooting star in the sky will never burn out. It could go up a lot farther in the sky before the next big bear market—but it always burns out,” he said.
