• A pie chart widely shared last week which compared the largest Technology stocks vs. the smallest stocks does not accurately represent the composition of the market
  • Large-cap Technology stocks have driven index returns YTD, but that’s because the entire sector has performed well including small-cap Technology stocks
  • Large-cap Technology stocks are up +15.3% YTD, and small-cap Technology stocks are up +14.0% YTD
  • Over the next 1-2 years, small-cap Technology stocks (PSCT) are poised to outperform large-cap tech stocks (QQQ)

The investing discussion on the internet last week was skewed toward the performance of the largest stocks YTD. One of the catalysts was a pie chart showing the largest 5 stocks, compared to the smallest 282 stocks. Perma-bears excitedly used the chart to prove the notion that the market is in a bubble driven by only the largest 5 stocks. It was widely circulated on twitter and other blogs. Michael Batnick, the original poster of the pie chart, was slightly annoyed by the conclusion many took away from this chart and did an in-depth blog post which showed that the ratio of large-cap stocks vs. small-cap is no different than the historical range.

In general, pie charts are considered by data visualization experts to be a poor way of communicating data. If a pie chart is used, it should include the total universe and not only two extremes of a population. In any weighted distribution, the largest group will be substantially bigger than the smallest group. For example, it would be misleading to show the US GDP vs. the GDP of the smallest 50 countries in a pie chart, which wouldn’t tell you much except that the US economy is very large compared to the smallest countries.

If all the stocks of the S&P 500 are included in the analysis, the charts would look something like the charts below. Visually this gives a more complete analysis of the topic.

Source: Koyfin

From an index perspective, owning the large-cap tech names has been important for keeping up with the benchmark in 2018. As an example, the Nasdaq 100 (QQQ) is up 15.6% YTD with six stocks accounting for 75% of the return or 1,200 bps: Amazon (AMZN), Microsoft (MSFT), Apple (AAPL), Facebook (FB), Netflix (NFLX) and Alphabet (GOOGL). Said another way, an investor would be up 3.6% YTD if he didn’t own these six stocks but owned everything else.


Source: Koyfin. Click here to see the QQQ holdings and attribution dashboard. You can also read our wiki about how we calculate attribution.
However this is more of a reflection that Tech is outperforming other sectors, not that large-cap is outperforming small-cap. A comparison of large-cap tech (QQQ) vs. small-cap tech (PSCT) confirms that the two groups have similar performance YTD.

Source: Koyfin. Click here to see this chart on Koyfin.

The ratio of PSCT (small-cap) vs. QQQ (large-cap) is another good way to see whether small-caps or large-caps are outperforming (to calculate the ratio in Koyfin, you can type PSCT:QQQ in the command bar). Over the past 18 months, small-caps have underperformed large-cap. However, looking over the past 10 years, the ratio is sideways and currently at the lower end of its 10 year range. On a mean reversion basis, there is scope for small-cap tech to outperform over the next 1-2 years.

Source: Koyfin. Click here to see this chart on Koyfin.

A fundamental catalyst for small-cap outperformance may be increased M&A activity driven by the large cash hoards on the balance sheet of large tech companies. AAPL, FB, GOOGL and MSFT have a combined $550 billion of cash on the balance sheet. Small-cap stocks would benefit from increased M&A activity as valuations get bid up and takeover premiums increase in the market. Admittedly the potential for this theme has existed because cash levels have been high for several year. But there is evidence that acquisitions are picking up in the tech space. For example, Paypal (PYPL) has done four acquisitions YTD compared to one over the past 3 years.

The small cap Tech ETF (PSCT) has about $400m AUM, is comprised of 94 small-cap Tech stocks and charges a 0.3% expense fee.

Source: Koyfin. See the Koyfin ETF snapshot for PSCT