If you’re benchmarking to a major stock market index like the S&P 500, then it helps to know the context of your industry weighting compared to the index. It helps explain your portfolio’s relative performance, and can create a “heat check” to how your portfolio is balanced and how it might react to an upcoming economic cycle.
Before evaluating the historical industry weights for the S&P 500 and how they relate to your own portfolio, it’s key to define the industries and their relation to the economic (super) cycle.
There’s many financial websites online which report industries and sectors, but since these categories aren’t standardized, they can be defined differently or named in a similar but different way.
Some examples of the industries (sectors) as I see them on most financial websites (like Finviz):
- Basic Materials
- Consumer Cyclical / Consumer Discretionary
- Communication Services
- Technology / Information Technology (IT)
- Financial / Financial Services
- Consumer Defensive / Non-cyclical
- Real Estate
Keep in mind that industry or sector categorization, and thus industry weights for the S&P 500 and other indexes, aren’t always completely accurate or representative for companies.
A company can be a conglomerate and have business segments which sell to multiple end markets in different industries. Or a company’s product and service could technically be defined as two different things—a good example is Google, which is defined as Communication Services due to the advertising driven nature of its business, but it’s also undoubtedly a technology company too.
It’s also key to define cyclical and non-cyclical, and how that can affect investment results. In general, cyclical or non-cyclical stocks perform in the following ways:
Cyclical stocks: Perform strongly during strong economic growth, and poorly during economic contractions
Non-cyclical stocks: Perform pretty consistently regardless of broader macroeconomic conditions
An easy way to understand cyclical vs non-cyclical stocks and industries is with a Utility company. No matter what’s going on with the economy, people need electricity, and so they will generally make those payments to their electric company even if they’re unemployed.
On the flip side, a technology company like Apple will probably sell less iPhones if many people are unemployed, since the latest model isn’t a “need to have” for most people and is a more discretionary purchase that is likelier to happen if a person has strong earnings and employment.
The Tough Problem of Defining Cyclical vs Non-Cyclical Industries
Like with the trouble with identifying a company’s industry when it touches multiple end markets of an economy, industries are generally exposed to economic cycles in varying degrees—it isn’t black or white.
Defining the cyclicality of industries outside of Consumer Discretionary / Consumer Cyclical is less universal from investors and institutions, though I thought this categorization from Morningstar to be a good general representation (Cyclical, Sensitive, Defensive):
- Basic Materials
- Consumer Cyclical
- Financial Services
- Real Estate
- Consumer Defensive
- Communication Services
A gut check on these definitions makes sense too. An industry like Communications might see higher demand during economic expansion (for example if lots of people upgrade to 5G because of high consumer confidence), but also have a floor against economic recessions (people still need their Netflix and cell phones). So it makes sense to put that industry in the gray area of “sensitive” to the cycle.
S&P 500 Industry Weights and Sector Structures
With all of that now properly defined, I’d like to take a recent snapshot of the S&P 500 and its industry weights and apply them to the “Morningstar Stock Sector Structure.”
To make this calculation, I used a recent list of current S&P 500 constituents and their sector, and their latest market capitalization (October 28, 2020).
It’s not a perfect measurement, as some companies are added and dropped from the S&P 500 index quite frequently, and the industry classifications might vary.
But like Warren Buffett says, “it’s better to be approximately right rather than precisely wrong”, and so that’s what we’ll go with for the S&P 500 industry weights highlighted in this article.
A few takeaways from this chart.
(I used 2010 and 2000 as representative of recent bear markets and over a span of different decades).
It appears that Communication Services and Consumer Discretionary are in a secular growth trend, while Financials and Industrials are in secular decline.
Technology (Information Technology), while agreed by many to also be participating in secular growth, appears to be more cyclical in nature. This could be market driven or economic driven.
I was surprised to see Energy higher in 2010 (9%) than in 2000 (6%) even though it’s so much lower today (2%). The Energy weighting could become a cycle that swings up and down rather than sits in a permanent down trend.
Historical S&P 500 Industry Weights and Sector Structures
Next I want to take the same approach but zoom out over many years. This will give us insight into how industry weights can change from year to year, and also give a baseline expectation for how to position a portfolio over the very long term.
Since I’m personally a very long term investor, with still a 35+ year time horizon to let my stock investments compound, I’d rather base my industry weights decisions on how the S&P 500 has looked over the very long term rather than what it looks now or how it looked last year.
This gives me a better shot at matching my performance close to the index over the very long term, and gives me a baseline (again) to measure how cyclically I want to try and weight my portfolio depending on how I perceive market conditions or the economic climate.
Again, this dataset doesn’t take into account historical S&P 500 additions and removals through the years, and is backwards looking. But it provides a decent representation of the overall picture.
Important: looking at S&P 500 industry weights is not meant to be a substitute to individual stock analysis, and it should not (in my opinion) guide investment decisions.
At the end of the day, your portfolio performance will depend on the long term financial performance of the underlying companies in your portfolio, much more so than any industry weighting decisions will.
Still, I find that at times there can be lots of attractive stocks to investigate, and so I find it helpful to examine S&P 500 industry weights to help me focus on a sector or prevent over-exposure to any economic factor—which would effectively reduce my margin of safety (a 100% cyclical portfolio would lead to a very bumpy ride).