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Navigating shifting market dynamics with Capital Group ETFs
Steve Fox
Client Analytics Director
KEY TAKEAWAYS
  • In 2024, we have seen the market fluctuate between broadening and narrowing conditions.
  • Historically, narrowing conditions tended to favor market cap weighted indexes like the S&P 500 Index, while broadening conditions tended to favor the S&P 500 Equal Weight Index and the S&P 500 Dividend Aristocrats Index.
  • Shifting dynamics like these highlight the benefits of Capital Group’s active management, which uses objective-based investing to find companies that have the potential for leadership across market conditions.

The growing dominance of a handful of stocks in U.S. markets has been a consistent theme in recent years. Today, the market is near levels of concentration that it hasn’t seen in decades.


But market dynamics like these can shift. In the most recent quarter (the third quarter of 2024), the market showed that hyperconcentrated markets can have periods of broadening. The broadening may or may not last — we can’t predict when market dynamics will shift, only that they likely will at some point.


Still, the past quarter’s broadening serves as a reminder that a long-term investor shouldn’t seek to mirror any one particular market too closely. Lessons from prior periods show that leading companies of concentrating periods may not be the same companies leading in periods of broadening.


As active managers, Capital Group seeks to find leading companies across market conditions, rather than tying our funds to a particular type of market. Two of our funds include CGDV – Capital Group Dividend Value ETF and CGGR – Capital Group Growth ETF (see the two preceding links for more information about these funds, including standardized results information). Both funds seek long-term investment success, but they take differentiated approaches, with CGDV seeking dividend opportunities and CGGR seeking growth of capital.


An unprecedented rise in market concentration


One way to measure market concentration is to compare the returns of a market cap weighted index, such as the S&P 500 Index, to an equal-weighted version of the same index. Market watchers and index-linked investment vehicles typically use the market cap weighted version, which gives outsize importance to the biggest companies in the index, such as the Magnificent 7 companies.


The S&P 500 Equal Weight Index strips out this concentration and invests equally in each index component. By comparing the relative results for each, we can gauge whether indexes are broadening or continuing to concentrate around a handful of companies. When the market cap weighted index does better, the most heavily weighted companies are outpacing lesser weighted companies in the index (“concentrating”). When the equal weight index does better than the market cap weighted index (“broadening”), the relatively lesser weighted companies in the index are outpacing the most heavily weighted companies.


This returns-based measure of breadth pairs nicely with the “effective securities” count used recently in a Capital Ideas article. Let’s say you want to create an equal-weighted portfolio of stocks that would provide the same level of diversification as the traditional market cap weighted S&P 500 Index. The effective number of securities tells you how many stocks you would need in this portfolio to achieve the same diversification as the index. As the index concentrates, it becomes less diversified, and the effective number of securities drops because fewer stocks will replicate that level of diversification.


By construction, a good portion of the market cap weighted index return is positively correlated with changes in concentration. As the number of effective securities in the S&P 500 Index declines, the market cap weighted returns exceed those of the equal weighted index returns.


Equal weight S&P 500 Index has tended to outpace the market cap weighted S&P 500 Index as diversification increases

A graph with two lines illustrates measures of concentration in the S&P 500 Index. One line shows the relative results of the equal-weighted version of the index divided by the market cap weighted version of the index. The relative results line went down in the late ‘90s, representing concentrating within the index, and it went up through the 2000s, representing broadening. Since roughly 2013, the line has trended down as the index has increasingly concentrated. The other line shows the effective number of securities in the S&P 500 Index. As with the relative results, the effective number of securities went down in the late ‘90s, signaling concentration. Then it went up in through the ‘00s, signaling diversification. Since roughly 2013, the effective number of securities has trended down as the index has increasingly concentrated.

Sources: Capital Group, FactSet. As of 9/30/24. The equal weight index divided by market cap weighted line is based to 100 as of 1/1/90 and shows the results of the S&P 500 Equal Weight Index divided by the results of the S&P 500 Index on a monthly basis from 1/1/90 to 9/30/24. The indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index.

Using this relative return analysis, we see that the ratio of the equal weight index to market cap weighted index is at a nearly 20-year low. Not only are the results heavily tilted toward the market cap weighted index, but the effective number of securities in the index has fallen by more than half during that time. Also of note is that the peak-to-trough differences in returns and changes in concentration for the 2000 dot-com bubble are similar to the 2015 to 2024 patterns.


Put together, this means that the S&P 500 Index is currently more reliant on a smaller number of companies, and those few companies are outpacing the rest of the index at levels not seen since 2008.


Lessons from prior periods of concentration


As with many indicators in financial markets, concentration has been highly cyclical, but with unpredictable timing. Despite the volatile nature of concentration, there are some critical observations that can both inform investment decisions and provide some comfort in taking a long-term perspective.


Relative returns of the S&P 500’s equal weight index against its market cap weighted index tracks with effective securities

A line chart shows the effective number of securities in the S&P 500 Index. Accompanied with the line chart are the relative returns of the S&P 500 Equal Weight Index versus the S&P 500 Index. As the effective number of securities in the S&P 500 Index declines, the S&P 500 Equal Weight Index trails the S&P 500 Index. After the effective number of securities troughs and begins to rise, the S&P 500 Equal Weight Index begins to lead. This pattern holds true through all 13 peaks and troughs since 1990.

Sources: Capital Group, FactSet. As of 9/30/24. Relative returns are cumulative from peak to trough or trough to peak on the effective number of securities, as represented by the numerated white and gray shaded periods on the chart. For example, from 1/1/1990 through 10/31/1990, the S&P 500’s equal weight index lagged the market cap weighted index by 12.40%. From 11/1/1990 through 8/31/1994, the equal weight index outpaced by 6.26%.

The peak-to-trough relative results of the S&P 500’s equal weight index to its market cap weighted index are not surprising in direction. As the market broadens from a period of peak concentration, the more diversified index (equal weight) has seen higher returns. Looking at results over a handful of extremes from October 1990 through September 2024 illustrates this and gives a sense for the cyclical nature of concentration.


As markets narrowed, the market cap weighted index has tended to lead the equal weighted index when results are positive (all 5 narrowing periods with positive returns). In the year that follows, the market cap weighted index falls behind, and either the equal weighted index or dividend-focused stocks (as represented by the S&P 500 Dividend Aristocrats Index) has tended to ”win” against the S&P 500 Index.


S&P 500 Index tended to lead in the year going into peak narrowness

The chart displays six separate line charts illustrating one-year returns of different U.S. equity indexes before and after market narrowing events. Each chart tracks the S&P 500 Index, the S&P 500 Equal Weight Index and the S&P 500 Dividend Aristocrats Index across these timeframes. The S&P 500 Index led in five of the seven “Before” periods, including all five “before” periods with positive returns. In the “After” periods, S&P 500 Index lagged either the S&P 500 Equal Weight Index or S&P 500 Dividend Aristocrats Index, or both.

Sources: Capital Group, FactSet. “Before” refers to 1-year total returns in the year leading up to the date, while “After” refers to the 1-year total returns in the year following the date. For example, in the first box, “Before” refers to 11/1/89 through 10/31/90, while “After” refers to 11/1/90 through 10/31/91. Due to the recency of the most recent peak narrowing date, the final “After” period reflects returns from 7/1/24 through 9/30/24.2

The opposite effect held for the pattern of “winners” for index returns in the one-year period before and after peak broadening; the S&P 500’s equal weight index led the market cap weighted index in all six broadening periods, then tended to lag in the following year.


S&P 500 Equal Weight Index tends to lead in the year going into peak broadness

The chart displays six separate line charts that illustrate the one-year returns of different U.S. equity indexes before and after market broadening events. Each chart tracks the S&P 500 Index, the S&P 500 Equal Weight Index and the S&P 500 Dividend Aristocrats Index across these timeframes. In all six periods, the S&P 500 Equal Weight Index led the S&P 500 Index in the “Before” period. In five of the six “After” periods, the S&P 500 Equal-Weight Index trailed the S&P 500 Index.

Sources: Capital Group, FactSet. “Before” refers to 1-year total returns in the year leading up to the date, while “After” refers to the 1-year total returns in the year following the date. For example, in the first box, “Before” refers to 9/1/93 through 8/31/94, while “After” refers to 9/1/94 through 8/31/95.

A closer look at broadening in the most recent quarter


When looking at the chart of the effective number of securities, readers with a keen eye may note an uptick at the end. The most recent quarter runs counter to the trend that has dominated recent history, and a broader set of index constituents outpaced the mega-cap companies.


To take a closer look at these shifts, let’s zoom in on 2024 results. The first half of the year followed a familiar pattern: Mega-cap tech propelled the S&P 500’s market cap weighted index much higher than its equal weight index and dividend-oriented index. In the third quarter, the situation flipped: Equal weight outpaced market cap weight, and the dividend-oriented index nearly doubled the returns of the market cap weighted index.


Third quarter index results diverge from patterns established in the first half of the year

Three bar charts compare total returns in the first half of 2024, the third quarter of 2024 and year to date. In the first half of the year, the S&P 500 Index led both the S&P 500 Equal Weight Index and the S&P 500 Dividend Aristocrats Index. In the third quarter of the year, the situation flipped, and the S&P 500 Index trailed both the other indexes. From the start of the year through 9/30/24, the S&P 500 Index returned roughly 22%, compared to about 15% and 14% for the equal weight index and dividend-focused index, respectively.

Sources: Capital Group, FactSet. Third quarter and year to date reflect results as of 9/30/24.2, 3

What's different about this period of concentration?


The past may offer clues as to what we can expect, but we do see differences between our current era of concentration and others such as in 2000 and 2008.


Rapid growth, as recently experienced by mega-cap tech companies, is sometimes associated with market “bubbles.” Prior examples include the dot-com bubble in the early 2000s and the housing bubble roughly five years later. In both those examples, the bubble ultimately burst when company fundamentals fell far short of what skyrocketing stock prices implied.


While valuations are stretched in some parts of the U.S. market, we aren’t seeing a broad, index-level disconnect between company fundamentals and stock prices. Some sectors of the market are posting impressive gains, but a closer look reveals a similarly impressive growth in earnings. Many sectors have slightly elevated price-to-earnings ratios compared to their recent averages, but they also have elevated rates of earnings growth.


Technology isn’t the only sector in the S&P 500 Index generating earnings growth

The chart breaks down the sectors of the S&P 500 Index (excluding real estate and energy sectors) by P/E ratio and EPS growth. The y-axis compares the current P/E ratio to the 5-year average. The x-axis compares EPS growth to the 5-year average. All sectors listed have higher EPS growth than the 5-year average, and all sectors listed except consumer discretionary have higher P/E ratios than the 5-year average.

Sources: Capital Group, FactSet, S&P Dow Jones Indices LLC. As of 9/30/24. Price-to-earnings (P/E) ratios are based on one-year forward earnings per share (EPS) estimates. Figures on the y-axis refer to the excess of the current P/E to its five-year average. For example, the S&P 500 Index lands at roughly “2x” on the y-axis because the index’s price was 21.6 times earnings on 9/30/24, while the index’s five-year average was 19.5 times earnings (a difference of about 2).  Current EPS growth is based on the annualized earnings growth for 2023 to 2026 across sectors based on 2023 actuals and consensus EPS estimates for 2024 to 2026. Historical averages for earnings growth are based on the annualized earnings growth between 2018 to 2023 for each sector. Due to their cyclical nature, real estate and energy sector historical averages are not as meaningful, and they have been excluded from this analysis.

Using active management to navigate shifting market dynamics


Navigating both concentrated and broadening markets requires an adaptive and strategic approach. However, in the long-term, return differences between the three indexes mostly wash out. In comparison to the S&P 500’s market cap weighted index, its equal weight index has tended to have more volatility (as measured by standard deviation), while its dividend-focused index has tended to have much stronger risk-adjusted returns, but the long-term average annual returns for all three indexes land in a narrow range.


Long-term index results (January 1990-September 2024)

Index Average annual total return Standard deviation Sharpe ratio
S&P 500 Index 10.6% 14.9% 0.57
S&P 500 Equal Weight Index 11.3% 16.5% 0.56
S&P 500 Dividend Aristocrats Index 11.8% 14.0% 0.68

Sources: Capital Group, FactSet. As of 9/30/24.

This points to the importance of active management with an objective-based approach. Attempting to seize on short-term leadership changes through passive index funds is not only difficult, but also becomes less important as time smooths the differences between index returns.


Actively managed funds like CGDV – Capital Group Dividend Value ETF and CGGR – Capital Group Growth ETF seek to invest in the most promising companies regardless of current market dynamics. Instead of tracking indexes, these funds adhere to an objective. In the case of CGDV, the objectives are to produce income exceeding the average yield on U.S. stocks generally and to provide an opportunity for growth of principal consistent with sound common stock investing. CGGR seeks to provide growth of capital, predominantly (though not exclusively) through larger, faster growing U.S. companies.


Read important investment disclosures


Capital Group ETFs post strong returns across a variety of market conditions

Four bar charts compare total cumulative returns in the first half of 2024, the third quarter of 2024, year to date and since the ETFs’ inception. In the first half of the year, the S&P 500 Index led both the S&P 500 Equal Weight Index and the S&P 500 Dividend Aristocrats Index but was outpaced by CGGR – Capital Group Growth ETF. In the third quarter of the year, the situation flipped, and the S&P 500 Index trailed both the other indexes, while CGDV – Capital Group Dividend Value ETF beat the S&P 500 Index and the S&P 500 Equal Weight Index. From the start of the year through 9/30/24, both ETFs have outpaced all three indexes. This also holds true since the inception of both ETFs, which was 2/22/22.

Sources: Capital Group, FactSet, Morningstar.1 As of 9/30/24.2, 3 “Equal weight” reflects the S&P 500 Equal Weight Index. “Dividend index” reflects the S&P 500 Dividend Aristocrats Index. First half results refer to the results from 12/31/23 to 6/30/24, third quarter results refer to results from 6/30/24 to 9/30/24. Year-to-date results refer to results from 12/31/23 to 9/30/24. “Since inception” results are based on the inception date of CGGR and CGDV (2/22/22) through 9/30/24.4 All results are cumulative total returns at NAV.

In the first half of the year, CGGR outpaced the S&P 500 Index with exposure to the same mega-cap companies that propelled index returns, while generating excess returns by finding opportunities in companies less represented within the index. In the third quarter, as rotation dynamics played out, CGDV outpaced the S&P 500 Index.


On a year-to-date basis, both ETFs have outpaced the S&P 500 Index, the S&P 500 Equal Weight Index, and the S&P 500 Dividend Aristocrats Index. This also holds true on a lifetime basis going back to the ETFs’ inception. This speaks to the benefits of active management, which allows research-driven decision-making to align funds with shifting market dynamics.


Rather than waiting for an index rebalancing to account for changes in the market, Capital Group’s researchers and portfolio managers can seize these opportunities in the nascent stage. Following the research rather than the index could potentially maximize the rewards when market shifts are cemented with index changes that passive investors follow.


Read all perspectives on equity markets

EXPLORE NOW
Published on November 25, 2024

Steve Fox is a client analytics director with 29 years of industry experience (as of 12/31/2023). He holds a PhD in economics from the University of California, Santa Barbara and a bachelor’s degree in economics and mathematics from the University of California, Davis.

Additional perspectives

Figures shown are past results and are not predictive of results in future periods. Current and future results may be lower or higher than those shown. Investing for short periods makes losses more likely. Prices and returns will vary, so investors may lose money. View ETF expense ratios and returns.
Market price returns are determined using the official closing price of the fund's shares and do not represent the returns you would receive if you traded shares at other times.
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There have been periods when the results lagged the index(es) and/or average(s). The indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index.
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  1. Calculated by Morningstar. Due to differing calculation methods, the figures shown here may differ from those calculated by Capital Group.
  2. When applicable, returns for less than one year are not annualized, but calculated as cumulative total returns.
  3. YTD (year-to-date return): For the period from January 1 of the current year to the date shown or from inception date if first offered after January 1 of the current year.
  4. ETF market price returns since inception are calculated using NAV for the period until market price became available (generally a few days after inception).        
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© 2024 Morningstar, Inc. All Rights Reserved. Some of the information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar, its content providers nor Capital Group are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Information is calculated by Morningstar. Due to differing calculation methods, the figures shown here may differ from those calculated by Capital Group.

The dot-com bubble was a period of U.S. stock market exuberance in the late 1990s and subsequent downturn in the early 2000s. Much of the buying frenzy focused on technology stocks and their involvement in the nascent commercial internet. The bubble burst in 2000 and troughed in late 2002.

Earnings per share (EPS) is the measure of a company’s profitability, and it’s commonly used in fundamental analysis. It is calculated by dividing a company’s net earnings (“profits”) by the total number of outstanding stock shares.

The housing bubble was a period in the early 2000s in which a combination of low interest rates and “subprime” mortgages to borrowers with poor credit created a frenzy of buying activity in the housing market. In 2007, home prices began to decline, and investors began offloading subprime mortgages from their portfolios. This sharp decline in the housing market popped the bubble and ultimately resulted in the Great Recession in the U.S. and the global financial crisis more broadly.

Magnificent 7 refers to seven companies (Microsoft, Apple, Alphabet, Amazon, NVIDIA, Meta and Tesla) whose stocks came to dominate the U.S. stock market indexes in 2023. The phenomenon is reminiscent of previous periods of market concentration, including "FAANG" stocks in the mid-2010s and "Nifty 50" stocks in the 1960s and '70s.

The price-to-earnings (P/E) ratio refers to a company's price per share of stock divided by the company's earnings per share. Also known as the earnings multiple, this measurement is a common tool in fundamental analysis that helps compare how relatively expensive one company's stock may be compared to another’s.

The S&P 500 Equal Weight Index (EWI) is the equal-weight version of the widely-used S&P 500 Index. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight - or 0.2% of the index total at each quarterly rebalance.

The S&P 500 Dividend Aristocrats Index measures the performance of S&P 500 companies that have increased dividends every year for the past 25 consecutive years. The index treats each constituent as a distinct investment opportunity without regard to its size by equally weighting each company.

S&P 500 Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes.

Sharpe ratio uses standard deviation and return in excess of the risk-free rate to determine reward per unit of risk. The higher the number, the better the portfolio’s historical risk-adjusted performance.

Annualized standard deviation (based on monthly returns) is a common measure of absolute volatility that tells how returns over time have varied from the mean. A lower number signifies lower volatility.