The Rise in Stock Market Concentration: What It Means for Investors

This narrow market rally has led to a remarkable increase in stock market concentration in the U.S. — a metric that quantifies the extent to which a small group of stocks dominates the total market capitalization. One of the most widely used measures of this concentration is the combined weight of the top 10 stocks. In June 2024, the top 10 stocks made up 37% of the S&P 500, surpassing the previous high of 33% set in 1963. ⁽²⁾ For context, even at the height of the tech bubble in 1999/2000, the top 10 stocks accounted for 27% of the S&P 500. ⁽³⁾

While an increase in market concentration is not necessarily a cause for alarm, it becomes a potential risk when paired with elevated valuations and decelerating earnings growth among these dominant stocks. This risk is particularly acute for passive investors, who may inadvertently expose themselves to the dangers of over-concentration in pursuing diversification. Notably, a substantial portion—around 25%—of the S&P 500 is now directly or indirectly linked to the AI theme. ⁽⁴⁾

Stock market concentration is not static; it ebbs and flows in long-term cycles. From the early 1960s until 1990, U.S. stock market concentration gradually declined. This trend was interrupted by a decade of increased concentration, culminating in the tech bubble of 1999/2000. Following this period, concentration levels declined once more until 2014. However, since then, the concentration among the top 10 stocks has surged dramatically, more than doubling their collective share from 14% to 37% in the S&P 500, marking the fastest increase over a decade. ⁽²⁾

In a recent, in-depth analysis of stock market concentration, Michael J. Mauboussin and Dan Callahan of Morgan Stanley Investment Management unveiled several insightful findings. ⁽⁵⁾ Two of these are particularly noteworthy. First, they observed that equity market returns tend to be higher during periods of rising concentration than periods of declining concentration. Second, active investors—those who purchase individual stocks to build diversified portfolios—tend to find it more challenging to outperform an index during periods of rising concentration than during periods of declining concentration.

To wit, in the decade ending in 2023, when the U.S. stock market concentration increased at the fastest pace, 90% of U.S. large-cap blend managers failed to outperform their respective benchmarks. ⁽⁶⁾ When the very largest stocks perform the best, it becomes difficult for active investors to keep up with, let alone surpass, the market. However, when the cycle turns and market concentration declines, the environment is more favourable for active investors.

At Nexus, we aim to provide our clients with superior long-term returns while minimizing real risks to help them achieve their financial goals. Put simply, we prioritize absolute returns, ensuring your investments grow steadily over time rather than trying to outperform a benchmark. In our view, our absolute returns have been quite satisfactory over the long term. For those who prefer the comparison, our recent performance has trailed behind the market indices during a concentrated rally. However, our long-term performance has kept pace with the equity markets in the decade ending 2023, despite an increase in market concentration.

We are committed to our disciplined investment strategy, which we believe has consistently served our clients well, and will continue to do so. Though challenges will inevitably arise, we will remain steadfast in our approach, guiding you through the complexities of the market with confidence and peace of mind.