Market indexes weighted according to capitalization can take on heavy structural biases that evolve over time, because they accord greater representation to stocks as they have appreciated and less as they have declined. This bias carries danger for investors at the best of times, and almost never more so than now.
Looking at the sector allocation of the MSCI USA index, 26% is allocated to information technology and 14% to financials. Two of the 11 sectors account for more than 40% of the index, as measured by weight. By construction, market-cap-weighted indexes bet on past successes, and the strong performance over the past few years of IT and financials has driven up their weights in the MSCI USA.
Most interestingly, looking at the main performance contributors of the MSCI USA over the six months through June, (Figure 1) shows the concentration of performers and the role of the so-called FAANG stocks — Facebook, Amazon, Apple, Netflix, Google (i.e., Alphabet) — in the U.S. equity market. Nine out of 10 are IT stocks, while the remaining stock, Amazon, officially being consumer discretionary, has a market behavior similar to an IT stock.