Written by John Plassard, senior investment specialist at Mirabaud Group
There has been a lot of talk about stock market concentration in recent years, as we have noted with attention (or horror) that the largest European and American market capitalisations are making the headlines. Apple’s recent rise (+7%) is one of the latest examples. However, we now seem to have moved on to a higher stage of concentration. Is this becoming dangerous?
The facts
Apple climbed 7.3% on Tuesday, its biggest one-day jump since November 2022, to close at a record high. The rally followed analysts’ assessments of the WWDC conference, at which the iPhone maker unveiled “Apple Intelligence”, its personalised AI system. Apple contributed almost 80% of the Nasdaq’s rise. In other words, without Apple, the Nasdaq would have been flat…
Meanwhile, since Nvidia CEO Jensen Huang first revealed how much he expected his company to benefit from the artificial intelligence (AI) craze in May 2023, Nvidia’s share price has gone in only one direction: up.
On that day, the company reported sales of $7.19 billion for the first fiscal quarter of 2024. 12 months later, sales had risen to $26 billion, an increase of 262%.
Since 22 May 2023, when Nvidia really took off, the company’s share price has risen by more than 280%, taking the chipmaker’s market capitalisation to more than $3 trillion.
These are just a few examples of the dazzling growth of large market capitalisations, which logically fuels the concentration of certain stocks in market indices.
Remember that in 2023, without the “Magnificent 7”, the S&P 500 would have risen by “only” 6% (compared with an overall performance of 24.7%).
An accelerating trend
In 2020, the “GAFAMs” (Google, Apple, Facebook, Amazon and Microsoft) accounted for almost 25% of the S&P 500, having seen their market capitalisation double in 18 months to more than $6.5 trillion.
Such a concentration of stocks was unprecedented for over 50 years. It was already seen as a major risk to the performance of the US index, since it had never been so dependent on a group of technology companies.
Today, the Magnificent 7 (Apple, Amazon, Google, Meta, Microsoft, Nvidia and Tesla) account for 31% of the S&P 500’s market capitalisation of the. Unprecedented.
The 10 largest US stocks account for 35% of the market value of the S&P 500 index, well above the 27% reached at the peak of the tech bubble in 2000.
However, there are 3 stocks that are “particularly problematic”: Apple, Microsoft and Nvidia. Indeed, the weighting of the top 3 stocks in the index – 20.36% – has never been so high for at least 40 years:
Another way of convincing you? The gap between winners and losers has never been wider.
Concentration at the top has (almost) never been so high
To understand the importance of the top 3 stocks in the S&P 500, it is important (once again!) to look back at the history of the index. In 1980, IBM was the largest S&P 500 company, representing 4.3% of the S&P 500. The biggest weighting for a stock (more than today) was in 1985, when IBM accounted for 6.4% of the US index.
It is interesting to note that some stocks have dropped out of the top 10. These include General Electric, AT&T, Coca-Cola, Merck, Royal Dutch and Procter & Gamble.
On the other hand, Tesla has entered the top 10 and the energy sector is making a comeback with Exxon, which had been absent for 8 years.
According to the Wall Street Journal, AT&T accounted for 13% of the US stock market in the early 1930s. General Motors represented 8% of the market in 1928 and IBM had a weighting of 7% in 1970 (it was close to this figure in 1985).
The Nvidia case
Much has been said about Nvidia in recent months. But there’s another way of looking at its climb: through its market capitalisation. According to calculations by Apollo, 34.5% of the increase in the market capitalisation of the S&P 500 since the start of the year has come from a single stock: Nvidia!
Ultimately, the extreme concentration of returns in the S&P 500 makes investors more vulnerable to the impact of a single stock on index returns.
Is concentration dangerous?
Concentrating on a small number of stocks and sectors is obviously risky for the performance of the S&P 500 and, more generally, for your portfolio. The information technology, financial services, healthcare and consumer discretionary sectors represent a combined weighting of around 65%.
However, there is no need to panic. There are two very specific examples that put things into perspective.
First, Berkshire Hathaway. Its stock portfolio comprises around fifty shares, but the 10 largest Berkshire holdings account for around 86% of the portfolio’s total market value.
Then, if we compare the performance of the equally weighted S&P 500 against the market-cap-weighted S&P over the past year, the largest stocks “help” the S&P 500, but the difference is not huge.
Returns over the last ten, and even twenty, years are a little more pronounced, but the difference is not glaring. This would suggest that a concentration of stocks is not as dangerous as you might think.
The question is more about the quality of the companies that make up the top 10 positions in a portfolio, for example.
It’s all about momentum!
According to Goldman Sachs analysts, the influence of momentum is a feature common to all episodes of stock market concentration. The “momentum” factor refers to the tendency of stocks to continue moving in the same direction. In each episode, the US bank’s researchers found that momentum recovered as the major market leaders outperformed, increasing their weight relative to the rest of the market and increasing market concentration.
Then, as market concentration peaked and fell, so did momentum.
According to the US bank’s report, investors have always been successful in investing in laggards (i.e. stocks with low momentum), even during market downturns. In 26 trend reversals since 1930 – when the Goldman Sachs long/short momentum factor fell by at least 20 percentage points over a three-month period – low momentum stocks appreciated in absolute terms in all cases.
The reasoning behind this is as follows: when markets start to deteriorate, investors flee from equities considered to be the most vulnerable to the cause of the market downturn and turn to equities perceived as safe havens, which boosts the long/short performance of momentum.
When the outlook improves and the market rebounds, investors turn away from the leading stocks and return to the laggards.
Conclusion
The expression “big is beautiful” has never been more apt, if one considers Apple’s weighting in the S&P 500 (and, more generally, in the top 10 stocks that make up the index). However, contrary to popular belief, this “concentration” does not necessarily entail a risk for the indices. Rather, it is the quality of these companies that needs to be taken into account.
