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Is SPX A Tech Time Bomb?

Managing tech's heavy weighting in the S&P 500.

The Wall Street Journal had a cautionary article about the S&P 500 becoming too top heavy in tech stocks. It notes that for the last few years, tech's weighting in the SPX has been about 19% but right now it is close to 24%. A few days ago Steve Russolillo who is a writer for the WSJ Tweeted the article saying that in buying the SPX now you're getting a technology momentum fund. I replied that later in the cycle the index is always a momentum fund.

At some point the area that is hottest (tech in 2000, financials in 2007, tech again now), after years of growing faster than the broad market, that hot area has a good chance of dominating the index and that is exactly what has happened with tech. This will repeat frequently over your investing lifetime and will coincide with market tops but not precisely coincide, meaning trimming tech now might be premature but when the market does show signs of rolling over, starting to prune the tech exposure might be a good place for defensive action.

The reality of broad indexes gravitating toward being momentum funds dominated by the hot sector in no way invalidates using indexed products. All investment strategies and products have vulnerabilities and long term success, I believe, hinges on understanding the drawbacks. If tech grows to 30% of the SPX like it did in 2000 then I would expect the sector to get very hard which in turn could lead to a relatively big decline as bear markets go, 30% is about average. If an investor with a suitable time horizon is heavily invested in an S&P 500 fund and it cuts in half on them, then of course that will be uncomfortable but whatever the magnitude of the next decline, we know that at some point the index will go on to make a new high. The investor simply needs to avoid doing something self-destructive, like selling after that large decline.

This is why for accounts above a certain size it might be appropriate to build a portfolio using narrower exposures than SPY and EFA. The "certain size" is coming down as commissions continue to decline. I used to think that at maybe $200,000 or so going narrower would not be too commission-intensive but with most online brokerages charging $5-$7 and all offering 100-200 ETFs commission-free, cost may becoming less of a factor. One thing that is not changing in this equation is the importance of an investor's willingness and ability to spend the time needed to manage narrow exposures like sector funds, industry funds, thematic funds or individual stocks. With enough time spent, most people can manage a portfolio well enough but obviously not everyone is interested in doing so and in that event broad based exposure will clearly get the job done assuming an adequate savings rate and the avoidance of self-destructive behavior.

Over the weekend I will follow up on what a narrow based portfolio might look like.