Market Concentration

Is the market becoming too concentrated? Is the domination by a few giant firms a new market paradigm, or an unsettling parallel to historic market crashes?

The S&P 500 is widely considered “the market.” It’s composed of the 500 largest publicly traded companies in the US, representing roughly 80% of the total equity market value. It’s one of the broadest and best gauges of the economy, and it is the answer when someone asks, “what did the market do today?”

It is, though, market cap weighted. The larger a company’s market capitalization, the bigger its weighting in the S&P 500. And when certain companies and industries experience fantastic growth (higher market caps), they come to dominate the index.

With the success of the Magnificent 7 in recent years, we are seeing concentration risk. The top 7 holdings in the S&P 500 are all technology, or tech-related companies and they make up one-third of the entire index. The other 493 components account for the other two-thirds.

The sectors that house the Magnificent 7 stocks account for over half (53.2%) of the entire S&P 500: Information Technology (AAPL, NVDA, MSFT), Communications Services (GOOG), and Consumer Discretionary (AMZN, TSLA).

We’ve seen concentration levels like this in the past, and it did not end well.

Over the past 100 years, only two other times have the top 10% of US companies accounted for more than 75% of total market capitalization: 1932 at the onset of the Great Depression and in 2000 at the height of the Tech Bubble.

Both cases are infamous as major market turning points. We worry that the current cycle could become another case study. With 77% of the market value concentrated in the top 10% of companies today, we’ve now matched or surpassed the 1932 and 2000 highs.

That’s the bad news. The good news is that when past bouts of concentration unwound, there were areas of refuge. The unwinding hit the highest market cap companies the hardest. The high-flyers during the expansion were some of the hardest hit in the unwind.

Thankfully, you don’t have to mimic the S&P 500 in your personal portfolio – you can avoid the concentration areas and look for value amongst the other 493 non-Magnificent 7 names. That is what helped investors in 2000. 

While the S&P 500 (using the SPDR S&P 500 ETF as proxy) fell nearly -50% from its peak in early 2000 to the bottom in late 2002, the equal-weight index (using the Invesco Equally-Weighted S&P 500 Fund as proxy) held up much better, falling only -20% at its worst point.

And while the S&P 500 took over 6 ½ year to recover the March 2000 peak, the equal weight index made it through the downturn with hardly a scratch, spending only 12 months in a drawdown from early 2002 to early 2003. From 2003 on, it was back in positive territory and up 75% by the time the S&P 500 clawed its way out of the hole in late 2006.

The S&P 500 may be the market, but it doesn’t have to be your portfolio. With the market at an extreme level of concentration, we don’t want our portfolios to look like it. We see areas of opportunity in more conservative areas of the market like Health Care, Consumer Staples, and Energy. Not only do many of these companies pay us healthy dividends each quarter, but we view them as quality value names to ride through anything the market throws at us.

If you have any questions about your account(s), if there has been a change in your financial situation or investment objectives, or if you’d like to schedule a complimentary consultation to learn more about how our team can help you navigate the market and achieve your long-term financial goals, please feel free to contact us at (406) 839-2037.

Data Sources: S&P Global, State Street Global Advisors, Kenneth R. French Data Library, Koyfin, Allied Calculations

The views expressed in this newsletter represent the opinion of Allied Investment Advisors, a Registered Investment Adviser. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment or services. The information provided herein is obtained from sources believed to be reliable, but no representation or warranty is made as to its accuracy or completeness. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results. Investments are not a deposit of or guaranteed by a bank or any bank affiliate. Please notify Allied Investment Advisors if there have been any changes to your financial situation or investment objectives or if you wish to impose or modify any reasonable restrictions on the management of your accounts through Allied Investment Advisors.