Reports

The Increasing Concentration of the U.S. Stock Market

Over the past decade, the 10 largest U.S. companies have significantly increased their share of the S&P 500 stock index. A decade ago, these companies accounted for 14% of the index. Today, they make up more than a third. This shift has largely been driven by the rise of the "Magnificent Seven" stocks: Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla. While some experts express concern about the risks this concentration poses to investors, others believe these fears may be exaggerated.

The Dominance of the Magnificent Seven

The U.S. stock market has become increasingly dominated by a small number of companies in recent years. The S&P 500, the most widely used benchmark for U.S. stocks, provides a clear illustration of this trend. According to a recent Morgan Stanley analysis, the top 10 stocks in the S&P 500, measured by market capitalization, accounted for 27% of the index at the end of 2023. This is nearly double their 14% share from a decade earlier. To put this into perspective, for every $100 invested in the S&P 500 index, about $27 is allocated to the stocks of just 10 companies, compared to $14 a decade ago. This rate of increase in concentration is the most rapid since 1950. In 2024, the concentration increased further, with the top 10 stocks accounting for 37% of the index as of June 24, according to FactSet data. The Magnificent Seven alone make up about 31% of the index.

Risk Implications of Market Concentration

Some experts are concerned that the growing influence of the largest U.S. companies on investors' portfolios may pose significant risks. For instance, the Magnificent Seven stocks were responsible for more than half of the S&P 500's gain in 2023, according to Morgan Stanley. This means that while these stocks have driven overall returns, a downturn in one or more of them could jeopardize a substantial amount of investor money. An example of this risk materialized when Nvidia lost over $500 billion in market value after a three-day sell-off in June, leading to a multiday losing streak for the S&P 500. Although Nvidia's stock has since recovered somewhat, the incident highlights the potential dangers of such concentration. Charlie Fitzgerald III, a certified financial planner based in Orlando, Florida, emphasizes that the S&P 500's concentration "is a bit riskier than people realize." He points out that "nearly a third of [the S&P 500] is sitting in seven stocks," which undermines the principle of diversification.

Why Stock Concentration May Not Be a Concern

Despite the sharp increase in stock concentration, some market experts believe the concern may be overblown. The S&P 500 tracks the stock prices of the 500 largest publicly traded companies, weighting them by market capitalization. This means that the larger a firm's stock valuation, the larger its weighting in the index. Tech-stock euphoria has contributed to higher concentration at the top, especially among the Magnificent Seven. Collectively, these stocks have surged about 57% over the past year, as of market close on June 27, more than double the 25% return of the entire S&P 500. Nvidia's stock alone has tripled during this period.

Diversification Beyond the U.S. Stock Market

Many investors diversify beyond the U.S. stock market, which mitigates some of the risks associated with high concentration. According to a recent analysis by John Rekenthaler, vice president of research at Morningstar, it is "rare" for 401(k) investors to own just a U.S. stock fund. Many invest in target-date funds, which automatically adjust the asset mix as the target date approaches. For example, a Vanguard target-date fund for near-retirees has a roughly 8% weighting to the Magnificent Seven, while a fund for younger investors aiming to retire in about three decades has a 13.5% weighting.

Historical and Global Context of Market Concentration

The current level of stock concentration is not unprecedented by historical or global standards. Research by finance professors Elroy Dimson, Paul Marsh, and Mike Staunton shows that the top 10 stocks made up about 30% of the U.S. stock market in the 1930s and early 1960s, and about 38% in 1900. The stock market was as concentrated, or even more so, around the late 1950s and early 1960s, a period during which "stocks did just fine," according to Rekenthaler. He notes that "we've been here before," and that such concentration in the past did not necessarily lead to negative outcomes. Additionally, when there were significant market crashes, they generally did not appear to be associated with stock concentration.

Comparison with Other Major Stock Markets

When compared with the world's dozen largest stock markets, the U.S. market was the fourth-most-diversified at the end of 2023, according to Morgan Stanley. This level of diversification was better than that of Switzerland, France, Australia, Germany, South Korea, the United Kingdom, Taiwan, and Canada. This suggests that, despite the high concentration of top companies, the U.S. stock market remains relatively diversified on a global scale.

Profitability of Major U.S. Companies

Another factor mitigating concerns about market concentration is the profitability of the largest U.S. companies. Unlike during the peak of the dot-com bubble in the late 1990s and early 2000s, the present-day market leaders generally have higher profit margins and returns on equity. According to a recent Goldman Sachs Research report, the Magnificent Seven "are not pie-in-the-sky" companies; they are generating "tremendous" revenue for investors. Charlie Fitzgerald III of Moisand Fitzgerald Tamayo emphasizes that these companies have substantial profits to back up their high valuations, unlike many firms during the dot-com bubble. He acknowledges the question of "how much more gain can be made," but underscores the solid financial performance of these market leaders.

Conclusion

The increasing concentration of the U.S. stock market, driven by the rise of the Magnificent Seven, has sparked a debate among experts about the potential risks to investors. While some warn of the dangers posed by such concentration, others argue that the fears may be exaggerated, pointing to historical precedents, global comparisons, and the robust profitability of the leading companies. Investors should consider these factors when evaluating the impact of market concentration on their portfolios and make informed decisions based on their individual risk tolerance and investment goals.