With the first half of 2023 nearly in the books, the median S&P 500 stock is trailing the year-to-date index return by a staggering 12.4%. Should that hold, it’ll be the worst relative performance since the Dotcom era, when the median stock underperformed the index by 22% in both 1998 and 1999.

It’s a disappointing turn of events for stock-pickers. Last year, their job was the easiest it’d been in more than a decade, as 59% of stocks did better than the headline index, and the median stock outperformed by 5%. The underlying strength was evident when comparing the equal weight S&P 500 to the market cap weighted index – that ratio rose steadily to multi-year highs.

That ratio has reversed sharply in 2023, and now sits near its lows.

Just 27% of S&P 500 constituents are doing better than the benchmark’s 13% gain this year. That’s on par with 1998, the most lopsided year of the last 3 decades.

To be clear, it’s quite normal for most stocks to underperform. An analysis of historical returns shows that a small minority of stocks make up the vast majority of long-term market performance. That’s a big reason why most investors underperform their benchmarks – picking stocks puts you at a statistical disadvantage. Investors with long-term time horizons must spend all their time looking for companies that will end up on the so-called ‘fat tails’ of the distribution curve – and a failure to find and own those companies will inevitably lead to underperformance.

So if the odds are stacked against us, why bother picking stocks at all? Because investors that do manage to find the fat tails are rewarded handsomely. The S&P 500 rose a healthy 26% in 1998. Seventy of its members, though, rose more than 60% that year, and 17 of them doubled.

In 1999, things were even more extreme. The S&P 500 rose another 20%, still double the long-term average for the index. But the top decile rose 3 times as much, and 30 stocks gained 100% or more.

This year, the fat tails are once again skewing index returns, but they’re doing it in a different way than they did in the late 1990s. Look how much shorter the list of big winners is this time around.

So what’s the deal? How are so many stocks trailing if the fat tails aren’t really even that fat? Well, there are two ways a stock can skew index returns.

1. Delivering outsized performance

or

2. Having a large weight in the index

In other words, blame the mega caps.

Even though there aren’t a great number of stocks sitting on the outer edge of the distribution curve that have jumped 80%, 90%, or 100%, the largest stocks (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla, and Meta) have all seen big gains.

Those 7 companies account for a quarter of the entire S&P 500 and can be thanked for pushing the index to new 52-week highs earlier this month. Meanwhile the equally-weighted index is meandering along without a trend.

Does that mean it’s time to bet against the index rally, since so few stocks are participating? Perhaps. But recent history is proof that narrow leadership can last for years at a time, through both bull and bear markets. Information Technology – the largest sector and home to behemoths Apple, Microsoft, and NVIDIA – has dominated returns over the last 4.5 years.

Since the end of 2018, every other sector has underperformed. Not just underperformed Tech – the 10 other sectors have all lagged the S&P 500 index.

Beating the market is hard.