Saturday, January 08, 2022
Apple hits record high
Trillion dollar firms are a problem for investors
From Clara Suchy
A new record: Apple becomes the first company in the world to be worth three trillion dollars. This is good news for investors at first – but if fewer and fewer companies are worth more, it could also become a problem for ETFs.
Apple briefly hit more than $ 3 trillion in market cap this week. That was a high point for the tech company, having even beaten Bitcoin on the stock market in 2021. The company achieves unprecedented value – and with it a strength in the financial market that is growing steadily. Hardly any investor is spared from the company – whether invested directly in Apple shares or not.
Apple isn’t the only company to take on new dimensions in value in the past few years. Since the company founded by Steve Jobs founded the trillion US dollar club in 2018, it has added six more companies. In addition to the iPhone manufacturer, this also includes Alphabet (Google), Microsoft, Tesla and Amazon. Meta (Facebook) briefly exceeded the trillion US dollar mark at the end of 2021, but has lost value again. Since the Saudi oil company’s IPO in 2019, Saudi Aramco has also been considered a trillion-dollar company.
For individual investors who invest specifically in these companies, the ups and downs in market value are nothing new. But ETF investors should also keep an eye on the performance of the so-called Big Five tech companies – i.e. all trillion US dollar companies except Saudi Aramco. After all, hardly any stock index is formed without these companies. “If a component of an index is weighted so heavily, the index is prone to strong distortions,” says financial market analyst Benjamin Feingold ntv.de.
Little diversification
ETFs, which are considered safe mainly because of their diversification, are becoming less and less diversified due to the strong rise of the Big Five. Especially, but not only, if an ETF is very technology-heavy – as in the case of the most famous tech depot, the NASDAQ 100 Index. More than 35 percent of the assets of all Nasdaq 100 ETFs are invested in just five companies: Apple, Microsoft, Amazon, Tesla and Meta Platforms. The same applies to the MSCI World Information Technology Index. According to estimates by industry followers, the ten most valuable companies in the index are weighted at more than 50 percent. That leaves the other half for 178 companies.
But other index funds, which are actually set up globally and should not be based on individual sectors, are often dominated by the Big Five. The American Standard & Poor’s 500 is an index that aims to track the 500 largest US companies. But even here, according to “Quartz”, the five largest companies in the index – Apple, Microsoft, Amazon, Meta Platforms and Alphabet – made up 23 percent of the index at the end of 2021.
Passive investors in particular often do not know that they are actually investing in ETFs, which would be badly affected by a shock in the technology market. Even a single bad news from the Google or Microsoft world would have a massive impact on the index development.
A vicious circle between the market and investors
In doing so, ETFs should be spared precisely this volatility in the market. For this reason, ETFs have become popular in the wake of the financial crisis. And they have proven themselves: The security of representing an entire industry and the broad positioning of the systems have meanwhile also survived the Corona crisis. The ETF market has grown in recent years – more and more money is being invested in stock indices instead of the traditional market.
But that also brings problems. It is not just the indices that are influenced by trillion dollar companies. The rapid growth of the ETF market in recent years also indirectly contributes to the increasing influence of the Big Five in the indices. That’s because passive ETF investors automatically invest more in heavyweights like Apple when the company’s market value increases. Because ETFs replicate indices 1: 1 and accordingly invest more in stocks that rise and gain in value. “That has a trend-enhancing effect on the stock exchanges,” says Feingold.
In addition, an ETF can only distribute one hundred percent. That is, if Apple’s capitalization increases by two percent, one or more companies somewhere in the index will lose a total of two percent of their value in that index. Conversely, this means that the Big Five passively gain more and more value via ETFs, while small companies gain in importance in the Index lose. “These are not necessarily the fastest growing companies, but simply the strongest,” says Feingold.
Can Apple go up any further?
Of course, these five companies’ share prices have resulted in incredible profits over the past two years. The corona crisis has also strengthened the technology sector again. From an investor’s perspective, being heavily weighted on tech firms isn’t necessarily a bad thing. “In fact, most of the profits of the S&P 500 over the past ten years can be traced back to the growth of companies like Apple and Amazon,” says Jo Seldeslachts, research associate in the Companies and Markets department at DIW Berlin, ntv.de. “In other words: Without these companies, the growth of the S & P500 would have been significantly lower.”
Apple is now traded almost like a Bond replacement. The question, however, is whether it will stay that way forever. In fact, the company is particularly vulnerable to one of its biggest worries for 2022: inflation. Unlike software and internet companies, Apple’s primary business is selling physical hardware products. So Apple’s profits will decline as wage, shipping, and raw material prices rise. The other big five like Amazon, Microsoft and Tesla are also affected by this problem.
In addition, Apple has little scope for price increases. Compared to the competition, the iPhone or iMac is already in the upper price segment. The ability to raise prices to offset rising fixed costs is therefore limited at Apple.
Feingold sees yet another problem that could affect several Big Five companies in the next few years: “They have all built up a quasi-monopoly.” Many of these companies already have monopoly lawsuits in the United States. For example, the video game company Epic Games has sued Apple for collecting 30 percent of so-called in-app purchases. Microsoft and Facebook are not spared by the antitrust authorities either. “I see the regulation as a big problem for the big US tech companies,” says Feingold. This could cause a shock in the tech market in the future – which will then be amplified by passive ETF investments in the largest companies.