A Little Less ‘Gig’ Economy, a Lot More Builders of ‘Things’
On Monday the Barron’s 400 Index kicked off its new “rebalance” semester amidst a very different market environment from the one it enjoyed during the prior six months. Judging by the meaningful changes made to its list of constituents, the index seems to be up to the task of navigating a clearly challenging environment with a very strong set of companies that differ pretty significantly from those it owned the last few years.
As a refresher, B400 selects a new group of constituents every six months, on the third Friday of March and September, replacing approximately 40% of the prior period’s selections and re-weighting all stocks equally. More exactly, its historical turnover rate since inception has been 41.8%; this time around it replaced 183 companies, or 45.8% of the list. This number in itself isn’t much larger than the historical average or that significant; however, the changes the index made were pretty dramatic, in our view, relative to what it has typically owned since the start of the current bull market. To understand why a deeper dive is needed.
For starters, the 54 companies in the Consumer Discretionary sector picked to the index last week was the lowest count for this group since March 2009, precisely at the market bottom following the 2008 financial crisis. Not only does this represent a nine-year low, but it is also smaller by 18 names than the average for the sector since Barron’s first introduced the index in 2007. The other sector well underrepresented in the new B400 relative to its historical average is Health Care, whose 31 selections are 17 less than the sector’s historical average of 48 companies per period. By simply adding the total count by which these two sectors are underrepresented relative to the index’s history, one can see that almost 9% of the new B400 is different from what it has owned in the past, based on these two sectors alone. Such deviations from history are where superior—or poor—returns are achieved, depending on the strength of one’s company selection. Professional investors call this ‘dispersion,’ which, in our view, is finally making its appearance among risk assets, in no small part as a result of central banks’ efforts to remove liquidity from financial markets as they continue to gradually tighten monetary policy.
What the index didn’t pick during its latest rebalance is as much of a story, in the context of today’s market, as what it did indeed select. The biggest surprise by far came from Energy, the heretofore-perennial earnings underperformer following the collapse of oil prices a couple of years ago. MarketGrader’s GARP methodology seems to be finally identifying some profitable, sustainable growth to go along with the ‘value’ found in the space, at least judging by the 43 companies from the beleaguered sector it picked last week. Not only is this higher than the historical average of 38 names picked to the index every six months since 2007, but it is the largest selection of Energy names picked to B400 since September 2009 when 45 companies were selected. For perspective, consider that just two years ago, in the March 2016 reconstitution, only 13 Energy companies were selected to the index, less than one third the current count.
The three largest sectors in B400 following last week’s rebalance are now Financials, Industrials—both of which hit the 20% limit allowed by the index’s rules—and Technology with 67 names, or 16.75% of the index. Here two points are worth making about these last two sectors, to which the title of today’s newsletter alludes. While Technology continues to be pretty well represented in B400, and largely in line with the sector’s historical average representation in the index of 17%, this exposure is quite different from that of major market cap-weighted benchmarks such as the S&P 500, where Technology accounts for 23% of the index’s weight; furthermore, the five largest Technology companies in the S&P 500 account for almost 13% of the index (even after Facebook’s recent swoon). Such weight, by the way, does not include Amazon or Netflix, both of which are classified as Consumer Discretionary (and neither of which is a member of B400). When those two are added to the five largest Tech names in the S&P 500 (an apt comparison given the high correlation between their stock price returns and the returns of technology stocks in the aggregate), the total weight of these seven companies adds up to almost 16%, the very definition of “top heavy” in our view. On the other hand, the 16.75% weight of Technology in B400 is evenly spread among 67 companies, each accounting for 0.25% of the entire index’s weight.
Lastly, a point about Industrials, which continues to show significant underlying fundamental strength as measured by MarketGrader’s company rankings on which B400’s selection is based. Not only is the current total of 80 companies in the sector 14 names higher than the historical average of 66 but, absent the index’s sector cap of 20%, 93 companies belonging to the sector would have been picked to the index last week based solely on MarketGrader’s fundamentals-based rankings of all US public companies. Furthermore, the current crop of Industrials in B400’s roster belongs in 19 different and diverse industries, clearly underscoring the vigor currently underpinning the US economy.Figure 1. Current Sector Weights in the Barron’s 400 Relative to Historical Averages*
*Telecommunications and Utilities, which are represented in the index by only a few companies, are not depicted in the chart since they have always constituted a very small portion of B400.
Source: MarketGrader Research
Changes Across Size Segments
The new count of 106 large caps constitutes the largest representation by this segment of the index since September 2014, when 112 companies with a market cap greater than $10 billion were selected. The current large cap count exceeds by 12 names the 10-year average of 94 companies, or 23.5% of all constituents.
Conversely, the new count of 68 small caps constitutes the smallest representation of companies with a market cap below $1 billion since March 2014, when 65 of such companies were selected to B400. The 10-year average of small cap companies selected to the index per rebalance is 94 companies, which means the March 2018 class trails the average by 26 small cap names.
With 226 names mid caps once again represent the largest size segment of B400 (56.5%). This is mostly in line with the 10-year mid cap average of 212 names, or 52.93% of the index.
Company Highlights
54 companies were selected to B400 for the first time ever, with the 10 largest being NextEra Energy, Inc. (NEE), DXC Technology Co. (DXC), Fortive Corp. (FTV), T-Mobile US, Inc. (TMUS), Principal Financial Group, Inc. (PFG), CoStar Group, Inc. (CSGP), IDEX Corporation (IEX), TransUnion (TRU), Burlington Stores, Inc. (BURL) and Huntsman Corporation (HUN).
B400 welcomed back 52 companies that had been prior members but had not been selected in at least two years. This includes the index’s back-tested period between December 1997 and August 2007. Excluding this period, the number of companies making their return after an absence of at least two years drops to 47. Notable among them are Pfizer Inc. (PFE), which was last selected during the index’s inaugural selection in 2007; Kimberly Clark Corp. (KMB), last selected in 2010; and Toll Brothers, Inc. (TOL), last selected in 2015.
Among the March 2018 class, 67 companies have been selected to the index in at least two consecutive years, while 40 have been its members for at least three consecutive years and 16 have been B400 constituents for at least five years running. This last, most exclusive group, appears below:
| Ticker | Company Name | Consecutive Years | Grade |
| LOPE | Grand Canyon Education, Inc. | 5 | 78.11 |
| ALK | Alaska Air Group, Inc. | 5 | 77.40 |
| ULTA | Ulta Beauty Inc | 5 | 75.17 |
| TJX | TJX Companies Inc | 5 | 72.55 |
| ROST | Ross Stores, Inc. | 5 | 71.71 |
| BOFI | BofI Holding, Inc | 5 | 67.71 |
| SWKS | Skyworks Solutions, Inc. | 5 | 67.04 |
| FFIV | F5 Networks, Inc. | 5 | 65.88 |
| CACC | Credit Acceptance Corporation | 5 | 65.64 |
| AAPL | Apple Inc. | 5 | 65.18 |
| EGOV | NIC Inc. | 5 | 63.91 |
| ORLY | O’Reilly Automotive, Inc. | 5 | 63.59 |
| NKE | NIKE, Inc. Class B | 5 | 62.53 |
| MANH | Manhattan Associates, Inc. | 5 | 62.20 |
| BIIB | Biogen Inc. | 5 | 62.15 |
| SNA | Snap-on Incorporated | 5 | 61.27 |
Source: MarketGrader Research
For more on the Barron’s 400 Index, please visit https://www.marketgrader.com/indexes/overview/Barrons_400
