The S&P 500 Index is dominated by a small number of companies. At the start of this week, its ten largest holdings accounted for nearly 40 percent of its performance.

Of those ten, the only one that is not a tech stock is the last one, Berkshire Hathaway (BRK.B). However, the investment holding company is aggressively pivoting its portfolio towards the tech sector now that company founder Warren Buffett is retiring.

Berkshire’s largest investment recently was a $4.3 billion stake in Alphabet (NSDQ: GOOG, NSDQ: GOOGL). In addition, Apple (NSDQ: AAPL) comprises approximately one-fifth of its equity portfolio. In that regard, Berkshire may be perceived as an indirect play on the tech sector.

Wonderful Businesses at Fair Prices

The key to Berkshire’s success has been Buffett’s commitment to buying industry leading businesses without regard to sector. He is famous for saying, “It’s far better to buy a wonderful business at a fair price than a fair company at a wonderful price.”

I’ve been thinking about the implications of that quote lately. During the month of November, the cap-weighted S&P 500 Index eked out a miniscule 0.13 percent gain. Over the same span, the equal-weight calculation for the index was up a stout 1.92 percent.

In between those two versions of the large-cap index was a respectable 0.85 percent rise by the small cap Russell 2000 Index. In short, it appears Wall Street has spent the past month gradually rotating out of the biggest stocks and reinvesting that money into smaller companies.

Economics 101

If that is true, then that bodes well for the overall stock market next year. If Wall Street believed that the economy was on the verge of recession, it would be selling stocks and buying bonds with that money.

That does not appear to be the case. Bond prices fell during the past week, meaning the supply of bonds outweighed demand for them.

At the same time, the CBOE Volatility Index (VIX) started falling last week as portfolio managers pared back on buying put options on the S&P 500 Index. Evidently, Wall Street now feels less need for portfolio insurance in the way of bonds and put options.

If that trend continues into next year, the implications are enormous. The market cap for the entire Russell 2000 Index is a little under $15 trillion; the top five holdings of the S&P 500 Index are worth more than that!

Fair Businesses at Wonderful Prices

The problem with applying Buffett’s philosophy to small cap stocks is that they are not industry leaders. If they were then they wouldn’t stay small cap very long!

That being the case, it may be wiser to buy fair businesses at wonderful prices when it comes to small cap stocks. If Wall Street accelerates its rotation from large caps to small caps, even a fair business can escalate quickly in value.

However, this is not the case of a rising tide lifting all boats. Wall Street will avoid unprofitable companies in slow growth sectors. Instead, it will overweight companies that are growing profits at an accelerating rate in high growth sectors.

That is why I do not advise using a sector fund to invest in small cap stocks at this time. Given the circumstances, I believe an actively managed fund that successfully mimics Wall Street’s behavior described above will perform far better.