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Charting the Market

Market Concentration Risk and How to Diversify Now

For the first time ever the top 10 names in the S&P 500 Index make up more than 30% of the total market capitalization. That’s more than during the dot-com days — right before that bubble burst. Is this extreme concentration a looming risk that could lead to another calamitous drawdown?

With four charts, I’ll show how this historic concentration happened, explain why the real risk is lower diversification, and share some thoughts on how to diversify portfolios.

Head of SPDR Americas Research

How Did 10 Companies Gain Control of One Third of the Market?

Ten firms making up 30% of the total S&P 500 Index market capitalization didn’t happen overnight (Figure 1). The current firms in today’s top 10 have, on average, been in the top 10 for 92 consecutive months — far longer than the average 68 consecutive month run for historical top 10s.1

The current top 10 appreciated significantly as a result of a variety of fundamental factors. The first catalyst was the rush to well-known, high-quality firms for stable earnings with strong cash flows during the pandemic. The rise of the Magnificent Seven, driven by the fervor around Artificial Intelligence (AI) and how those firms used AI to boost their long-term top- and bottom-line growth, has continued propelling market concentration.

The top 10 firms grew earnings-per-share (EPS) by 31% versus -5% for the rest of the market in 2023.2 For full year 2024, the top 10 are expected to post 20% EPS growth versus just 8% for the rest of the market.3

Those fundamental trends help explain today’s extreme concentration: Market share gains didn’t result from bubble mania, but from these firms returning so much more shareholder value through higher cash flows and earnings than the rest of the market.

How Did Lower Diversification Become Risk #1?

The biggest risk of extreme concentration isn’t a massive market drawdown after a bubble bursting — even if regulators were to try to break-up big tech. Rather, reduced diversification is the more immediate risk to portfolios because:

1) The market power of a few names is a global trend. The top 10 firms in the S&P 500 Index now make up nearly 20% of total global market capitalization (Figure 2).

With outsized returns of those larger firms driving broad-based US equity returns above non-US markets (the S&P 500 Index is up a cumulative 38% since the end of 2020 versus just 5% for MSCI ACWI-Ex US Index), 4 the US now makes up more than 60% of the global market cap. This is the highest since the dot-com days, meaning global equity benchmarks have lesser geographic diversification.

2) Industry concentration has led to a record level of sector concentration among the top names (Figure 3).

The top two sectors — Information Technology and Communication services— make up 25% of the S&P 500 Index’s market capitalization. This record high surpasses the 20% level from the top two sectors during the dot-com days. Prior to this recent run of dominance, there were at least 6.3 sectors represented in the top 10, on average.5

Today there are just four sectors (Consumer Discretionary and Financials along with the two above), tying the recent record low from 2021 and underscoring the top of the market’s lack of sector diversification.

Figure 3: Two Sectors Make up More than 25% of Total S&P 500 Market Cap

3) Given the growth profile of the top ten, there is less style diversification than usual.

The S&P 500 Index now has two times more allocated to Growth (46%) than Value (21%) stocks,6 where typically the allocations have been the same (31% versus 32%), on average over the past 30 years.7

The broader US equity market also has more disparity across market cap styles. The combined group of mid and small caps now accounts for just 7.9% of total market capitalization within the S&P 1500 Total Market Index, the lowest percentage ever and well below the 30-year average of 11.2%.8

Does the Concentrated Market Foreshadow a Drawdown?

The average return for the top 10 in 2023 was 85.6% versus 16% for the other 490.9 As a result, the top 10 drove 63% of the S&P 500 Index’s total return,10 far more than what the top 10 typically contributes. The top 10 stocks represented 24% of the total return over the past 30 years, on average.11 And in 1999, they contributed 43%.12

The outsized influence on recent returns being far greater than the dot-com concentration supports the narrative that extreme concentration could be a harbinger of market doom.

But there is no connection to levels of market concentration and the subsequent 6- or 12-month forward returns. (Figure 4). The R-squared of the returns to the starting point of market concentration are 0.04 and 0.07, respectively.13 There is also less impact from the top 10 on the way down than on the way up. The top 10’s contribution to return (29%) during years with market gains is greater than years with market losses (12%), on average.14

Figure 4: Market Concentration Has No Predictive Power on Future Returns

Redistribution of fundamental earnings growth will likely be the catalyst that restrains the top 10’s impact on the market over the next year. By Q3 2024, non-top 10 firms are expected to post equivalent EPS growth as the top 10 — and then outpace the top 10 in Q4 (23% versus 15%).15 Fundamental trends mattered on the way up after all.

How Can You Increase Diversification to Combat Risk?

With only a few names making up a large portion of global markets, there is less geographical, sector, and style diversification within today’s equity portfolios. How could you increase the diversification in today’s concentrated portfolios?

  1. Increase exposure to US mid caps and small caps closer to historical averages (~11.2% versus 7.9% now).
  2. Add non-US equities, like developed ex-US equities or emerging market exposures.
  3. Use a sector strategy to help ease the outsized sector concentration at the top. For example, pair an equal-weighted portfolio of the sectors not found in the top 10 (Energy, Materials, Industrials, Real Estate, Consumer Staples, and Health Care) with a sector-concentrated large-cap exposure. This also might help reduce the portfolio’s Growth bias, as those six sectors are Value-oriented.
  4. Implement a systematic fundamental large-cap core exposure that owns all the stocks in the broader market, but uses fundamentals and risk sensitivities to weight firms beyond just market cap.

Look to our ongoing coverage of market trends and industry insights for more ideas on how to tamp down the influence of the top 10 on the broader portfolio.

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