Despite a fantastic first quarter, analysts see trouble in the leading stocks and their hegemony over the market.

Most stock market skeptics evoke the popular analogy of a bursting bubble to describe what will happen when the market drops. The Economist, a UK-based magazine, featured such a bubble illustration on one of its covers this past fall, a warning unheeded by investors who pushed the Dow to a record, ballooning 10,000. The Nasdaq Composite and the S&P 500 followed suit and broke their own records.
Financial gurus pleased, yet uneasy, with the untiring market don’t exactly see a market-wide bubble developing, but something worse, perhaps: The entire market isn’t ballooning and pushing the Dow to new heights. Rather, a handful of stocks in a limited number of industries support the market’s flagging growth. The result is a record-breaking market perched precariously on the backs of a few overpriced, super-huge stocks.
“It’s the same old story,” said George Pendergast, an investment consultant with Boston-based The Cambridge Associates. “Something like the top 20 top performing stocks have accounted for 80 percent of the performance.”
One-third of the S&P 500’s performance since the new year comes on the back of two stocks: America Online Inc. and Microsoft Corp., both of which rose an amazing 86 and 26.3 percent respectively, this year.
The Dow industrials is in a similar position. It owes more than half its gain to three stocks: American Express, J.P. Morgan and United Technologies, all up at least 17 percent in 1999.
So far this hasn’t been such a bad thing, especially for investors with big holdings in some of those top 20 stocks. Even the University cashed in. Its $573 million endowment fund gained 24.7 percent in 1998, a large part of which is owed to heavy investments in large-cap technology stocks like Dell Computer.
One of the portfolios of which the University’s endowment is comprised shot up 53 percent thanks to its huge holdings of large-cap, big-name technology stocks like Intel, Worldcom and Dell Computer.
For private investors who bought into such growth stocks, market expectations have changed drastically. The same people who in the early 1990s happily accepted 8 to 11 percent returns per year now shirk at anything less than 20 percent — even 30.
Money-making investments attract more money, and that’s exactly what continues to happen. With the top 20 stocks rising so precipitously, crowds of people have shifted money away from small and mid-cap stocks and into the large-cap stocks, those with a total share value of more than $5 billion.
As more money flows into those top 20, their prices soar so high that share values fail to accurately reflect the earnings of the company.
“When you think of the typical 401(k) investors who work on a factory floor, they don’t care about valuations or price/earnings ratios,” Pendergast said. “They just want to buy IBM.”
As Pendergast warned the Board of Regents last month, large-caps can’t keep going forever, and measures should be taken before the share prices of the top 20 sink back down into more reasonable territory. Pendergast’s opinion is shared by most analysts, including Abbey Cohen of Goldman Sachs, one of the more prominent Wall Street pundits.
To support their argument, analysts point to the gap between the market at large and those top 20 stocks.
Mutual fund performance is just one indication of the poor performance of most stocks. While the Dow is up a hefty 6.6 percent since Dec. 31, and the S&P 500 up a healthy 4.6, the average mutual fund is up less than 1 percent for the first quarter, according to Lipper Inc., the market analysis arm of Reuters News Service.
Furthermore, the average stock is down 6.4 percent for the year, according to the Value Line Index, a measure of 1,700 major stocks.
Pendergast said the trend will likely continue until the everyday investor starts pulling money away from the large caps and turns instead to long-neglected and undervalued small- and mid-cap stocks — something he doesn’t expect to happen very soon.