The past year has been good for those who happen to hold US equities. The S&P 500 is up by almost 30% over the last twelve months and by around 7.5% so far this year. Which given that March only just started is a very strong return indeed. Investment commentary though, and the opinion pages of the financial press, are filling up with fretting over rising levels of stock market concentration. The fear is that the headline numbers of a strong market rally mask an increasingly narrow set of stocks driving the wider indices.
Talk of rising equity market concentration has usually been coupled with fears of some sort of irrational exuberance, when it comes to hopes for the potential future profits from rapid developments in artificial intelligence (AI) technology. Since late 2022 and early 2023, AI has been the hot new thing for investors and money has piled into the shares of firms with exposure to this trend.
Much attention has been focused on a group of stocks now collectively known as the Magnificent Seven – Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla – all of which, to a greater or lesser extent, can claim exposure to AI. As Russell Investments recently noted, these seven companies alone accounted for more than half the S&P 500’s returns in 2023. Given the combination of stellar returns and excited chatter of emergent new technologies driving a revolutionary shift in productivity and profits it is unsurprising that, as Katie Martin recently wrote in the Financial Times, some analysts have begun to draw parallels with the dot com boom and bust of the 1990s and early 2000s.
US equity returns being dominated by a relatively small group of tech firms is nothing new. Today it might be the turn of the Magnificent Seven (named for the 1960 cowboy movies, although it is unclear exactly which tech boss gets to be Steve McQueen in this analogy) but just a few years ago oy was the FAANGs, or Facebook, Apple, Amazon, Netflix and Google. Indeed given that Facebook is now Meta and Google is Alphabet, the overlap between the two is large. More broadly, over the last decade the annual total returns from the S&P500 have been just over 10%, whilst those from the tech-heavy NASDAQ index have been closer to 14% – a considerable annual outperformance.
But if tech-led equity returns are not that unusual in recent financial history, the resulting rise in market concentration is more out of the ordinary. JP Morgan noted in mid-February that US stock market concentration, on at least one measure, is now at its highest levels in six decades. The weight of the ten largest components of the S&P 500, as of mid-February, accounted for 29.4% of its total value. That is up from around 20% five years ago and above the peak of around 25% hit during the dot com years.
Although as John Authers noted this week at Bloomberg, by international standards the US market remains unusually diversified. The ten largest components are more than half of the value of the benchmark index in Italy, France and Hong Kong and just shy of 50% in the UK. In Authors’ view the rise in US concentration is not “terrifying” but it is “disquieting”.
It has certainly been disquieting for active asset managers who have, in general, as Authors notes been underweight the Magnificent Seven and consequently underperformed their benchmarks. Over at CNBC, Bob Pisani feels the fretting over concentration has gone too far and has urged investors to relax a little. Concentration, as he argues, is a feature not a bug of market capitalization weighted indices – they reward winners and penalize the losers.
The evidence, from at least two studies of different markets, is that higher levels of equity market concentration do not, despite what one might assume, tend to increase the volatility of returns. Although, more concerningly, sharp rises in concentration have tended to presage market falls.
With commentators and analysts debating whether rising concentration is a cause for concern or not, the Clark Center asked its Finance Experts Panel this week whether, with concentration at new highs, investors seeking a well-diversified passive equity portfolio should consider alternatives to traditional market capitalization weighted indices.
Sadly for those seeking a clear-cut answer, opinions were divided. On the raw data, 24% of those surveyed agreed with the proposition whilst 29% disagreed. Weighting those answers by confidence shifts the numbers to 47% disagreeing against 31% agreeing, a clearer but still not decisive view.
In other words expert opinion, much like the views of investors, analysts and commentators in the press, remains divided. Rising concentration may or may not be a cause for concern although it remains important to hold onto the distinction between concentration, as trend in and of itself, and the wider but related fear of hopes of AI as a game changing technology being overblown. Perhaps those hyping up the Magnificent Seven should keep in mind that in the original movie, only three of the gunslingers survived.
