By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Not much was expected from the capital markets in 2023 given the Federal Reserve’s focus on tamping inflation. Could 2023’s capital markets be as testy or worse? Well, what has transpired so far this year has caught a lot of folks off guard, including me. Few would have predicted that the S&P 500 would climb by 18.5% as of August 31, 2023, especially in the face of continuing rising rates and a short-live “banking crisis”. US interest rates, as measured by the Fed Fund’s Rate (FFR) are up 525 basis points since March 17, 2022. Yet, economic activity and the US labor force have seemed to shrug off this development with little difficulty.

But is this a fair depiction of what has truly occurred? We would say, “no”! Yes, the S&P 500 has advanced by 18.5% through the end of August, but the rally has been far from robust. In fact, seven securities, primarily Information Technology, which now makes up 28.2% of the index, have advanced roughly 50% YTD, while the average stock in the index is flat to down. Is that masking of reality impacting asset allocation decisions? Are plan sponsors and their advisors hanging on to these exposures in the hope that they are a prelude to a broadening of market leadership within the S&P 500? At present the “Magnificent Seven” account for 25.5% of the S&P 500 capitalization weighting and the top 10 holdings (as of 9/12) accounted for 34% of the index’s weight. I don’t recall another time when a concentration of this magnitude existed during my more than 41 years in the industry.

It would be one thing if the huge price gains of the Magnificent Seven were driven by earnings growth, but that isn’t true. In fact, most of the 18.5% gain (68% according to a UBS report) for the S&P 500 has been the result of P/E expansion. That isn’t a foundation on which I’d want to put too much weight. Given the dramatic rise in rates at what point do all equities come under selling pressure? Would you want to own the capitalization weighted index at this point? If you’ve been fortunate to have exposure to the S&P, would it not make sense to sell “high” and use the proceeds to secure some of those promises that have been made to the plan participants?

Equities appear to have had a phenomenal run this year because of the nature of the index’s construction, but an equal weighted index has appreciated only 1% according to the Invesco ETF RSP. Other asset classes have continued to struggle, with most remaining below 2021 peaks. It is time to get off the asset allocation rollercoaster driven by the focus on return. The current US interest rate environment is providing plan sponsors with a wonderful opportunity to take risk off the table. For better funded plans, significant risk should be withdrawn. We have an opportunity to secure benefits while also expanding the investment horizon for the alpha assets that remain in the plan. Don’t let this opportunity slip through our fingertips like we did at the end of the ’90s.