Mind the Gap in the S & P

There is a lot of talk these days with regards to the wealth gap, and rightly so. An increasing wedge between the rich and poor can undermine the entire capitalist system and lead to societal issues, economic disruptions and conflict. Especially in the past few years we have witnessed various manifestations of this phenomenon, however the labels we ascribed to these symptoms did nothing more than obfuscate the true nature of the problem.

The global population is increasingly divided between the so called haves and the have-nots. In the western world this is perceived as a natural occurring phenomenon, a proof of concept for the capitalist mindset, where hard work, perseverance, intellect can lead to outsized returns, under the protection of a just law system protecting property rights and aided by a market economy which would enable the free-flow of goods and services as well as capital to chase the best available opportunities.

You will have heard by now many pundits claiming the system is now broken. I happen to subscribe to that point of view. Perhaps too slow to be noticed, the current system has drifted away from what we typically view as Darwinian, where the fittest are the ones that survive, to a perverted new sort of blend which Warren Buffet eloquently called - capitalism for the poor and socialism for the rich. Perhaps social class now dictates if one gets the best or the worst of both systems combined. Sure we can dwell on how this came to be and where it is likely headed but this is not the aim of this piece.

Surprisingly, there is another wealth gap which I want to talk about and it is not what you might think. Being keenly passionate about investments and markets it has been staring me dead in the face, and the current distortions created by the pandemic and subsequent federal reserve induced “prosperity” made the matter acute enough to take note.

It is the S&P 500 wealth gap. Let me give you some interesting statistics to illustrate my point:

The largest company, with a market cap close to $2.5 trillion is Apple. No surprise here. The smallest company, coming in at a respectable $ 5 billion is, at the time of this writing, NOV Inc. If like me you find yourself unaware yet eager to satisfy the curiosity of what this mysterious company might be up to I provide their Wikipedia description below:

NOV Inc. is an American multinational corporation based in Houston, Texas. It is a leading worldwide provider of equipment and components used in oil and gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry.

At a first glance you may be thinking, trillion, billion...potato, potato, until one realizes that currently AAPL is worth 489 times NOV. If this does not impress you, perhaps the following points will.

The top 10 companies in the S & P account for over 30% of the entire index. The top 30 companies account for about 44% and once you pass the top 40 you already passed the 50% mark.

At the very least this should worry you with regards to the diversification of your investments. So much for Modern Portfolio Theory. A deeper dive would illuminate some other, perhaps more troubling aspects. The concentration of wealth and implicitly that of power, is shaping our society, in many ways to benefit the few at the top which at this point would have an inherent imperative to protect their position in the ranks, and the means and venues to alter the rules to suit their objectives. Whether achieved by tempering with laws by wielding political power or dictating international policies that create winners and losers, there are countless ways the strings are pulled to ensure that just like in the illustration on the Dollar Bill, there is an increasingly insurmountable wedge placed between the peak of the pyramid and its bottom. Perhaps no aspect is more apparent and prevalent in our society than the way the tax system impacts these corporations. Below you will see the tax expenses reported by the top 10 companies.

I am bewildered as you must be watching the table above... that Tesla paid taxes in 2020 after finally reporting their first earnings and is now leading the pack with the highest tax rate of the group. The pandemic has worked in mysterious ways, but this is not the point I am trying to illustrate.

In a country where the average corporate tax rate is 21%, these behemoths managed to pay significantly less. Considering that the numbers above reflect only the amounts provisioned for taxes, rather than the actual amounts paid, the reality could be even more dire. That the rich pay lower or no taxes is no secret. The previous US president took pride in this matter and turned it into a selling point throughout his two campaigns. The bigger problem emerging is that like with individuals, we are slowly drifting towards a market dominated by a few giant players, which have limitless funding power to alter the functioning of society as they see fit. The remainder are falling further behind. The rich pay no taxes, the poor can’t pay taxes and the middle of the pack is disappearing - a vicious cycle which typically ends in tears.

From an investing point of view, we have a bar-belled market where the ultimate diversification tool, the index fund, will have one’s assets highly concentrated in a handful of companies, which ultimately set the rules for the others and brings into question the correlation coefficient. The valuation of these assets is yet another matter which boggles the mind.

The average PE of the top 10 companies in the S&P stands gloriously at 69 which, when compared to the historical average and mean of the index, which hovered around 15, to say that the current multiple is over extended is a severe understatement. What this means is that investors seeking the safety of a diversified index fund will end up with a portfolio having significant concentration in a few positions, which at least judging by historical norms are extremely overvalued.

What we have here then is a polarized world where the equilibrium is somehow still maintained, with a few heavyweights on one end of the lever aided by the benevolence of central banks and the rest of the world on the other, those that set the Standards and the Poor.

Disclaimer

This article by Cozar Investments is general in nature. We provide commentary and content that is educational in nature which is based on historical data, analyst forecasts using an unbiased methodology and multiple other sources. Our articles are not intended to be financial advice but rather to provide market commentary. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. To assess the suitability and merits of any investment opportunity we encourage to consult your financial advisors as the situation warrants it. We aim to bring you long-term focused analysis driven by fundamental data. While we make every effort to ensure the accuracy of the information presented using only sources we believe to be reliable, please take note that this analysis may not incorporate the latest price-sensitive company announcements, quantitative or qualitative material and we provide no representation or warranty, expressed or implied with respect to the accuracy of the material.

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