In recent years, a handful of companies have dominated the US stock market, and, with the US being the largest of the world’s markets, those companies have come to dominate global indices too. The collective noun for this group of companies has changed a few times, with the current trend being “the magnificent seven”. This has resulted in a lot of concern about “concentration risk” and called into question whether investors are achieving the desired diversification benefits (and whether such concentration might lead to a market downturn) – particularly in global or US index tracking funds. In the middle of last year, the ten stocks with the largest market capitalization in the US S&P 500 index made up about 35% of that index (with the other 490 stocks making up the rest). All but two of the top ten companies are in the technology sector, suggesting that future weakness in that sector could have an outsized impact on the returns of the index as a whole.
To assess the impact of periods of high market concentration, such as this, researcher Bryan Taylor in his paper “Two-Hundred Years Of Market Concentration In The United States” looked at stock returns from 1790 to the present, dividing this era into seven different periods. I spent an exciting couple of hours on Sunday reading through it!
Taylor found that periods of market concentration have not been uncommon over the years and, in various periods, different industries have been at the top of the pile – from banks to energy and, most recently, technology. Current levels of concentration are, however, as high as they have ever been, in the period going back to 1850. The chart below shows the top 10 US shares as a percentage of the top 500 US shares, from 1875 to 2024.
Concentration typically increases during bull markets (this has been the case for the last ten years or so) and decreased during bear markets. Bull markets are periods when share prices are rising, whereas bull markets are the periods when they fall. It would be easy to conclude that if the market has reached a certain level of concentration, a bear market is inevitable, but Taylor’s research shows that this isn’t the case. A period of high concentration isn’t immediately followed by a bear market. In particular, high levels of concentration can persist – the railways dominated for 25 years, and seven companies remained in the top 10 during the 1930s, 1940s and 1950s.
The current period started back in 2014, when Apple and Microsoft became the largest companies in the world. Back then, they were the only two technology companies in the top 10; today, there are only two non-tech companies in the top 10, and one of them, Warren Buffett’s Berkshire Hathaway, has 40% of its portfolio in Apple stock!
Whilst we may have high levels of concentration today, it is possible that we may still be at the beginning of a multi-decade period of tech-dominance. Or a market crash next week might herald a change in the companies that dominate. As usual, the answer to uncertainty is diversification; you don’t have to make a decision when you can have a foot in each camp. Index tracking funds will certainly give you exposure to the Magnificent Seven, but they will also leave you exposed to a change in their fortunes. It makes sense to have exposure to funds which are actively managed, and which may be able to adapt if the investment climate begins to change.
If you would like to discuss your portfolio, please contact us.
The original paper can be found at https://globalfinancialdata.com/200-years-of-market-concentration
Philip Wise | philip@sussexretirement.co.uk
Managing Director and Chartered Financial Planner
This blog is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.
