The Numerous Quirks in The Market Today

Market concentration has rarely been higher. What is market concentration? The S&P 500 Index is a market-capitalization weighted index which means that each stocks weight in the index corresponds to its size (shares outstanding x share price).  

The chart below shows that the largest 7 companies, what the media has dubbed the Magnificent 7. Apple, Meta (Facebook), Microsoft, NVIDIA, Amazon, Alphabet and Tesla have driven the overwhelming majority of the gains in 2023. 

The top five of those, Meta, Amazon, Google, Microsoft, and Apple, are now nearly one-quarter of the entire S&P 500 index. These companies are truly MASSIVE.  

^{Source: Bloomberg, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management as of 09/25/2023. Chart shows the market capitalization of five mega-cap companies in the S&P 500 Index.}

I can remember in 2000 the article suggesting that the 18% weight of the five largest companies then, Microsoft, Cisco Systems, General Electric, Exxon Mobile, and Intel Corp, were extreme. Today, they are another 50% higher.  

Valuations too are getting elevated. Although not as high as recent history, the current price-to-earnings ratio over the next twelve months is almost 40% higher than the market as a whole. 

The problem can somewhat be attributed to a self-reinforcing dynamic. That is, most investors today invest via index funds. Those index funds follow the weights of the index as closely as possible. Higher stock prices can fuel market capitalization gains, which then force the index funds to add more shares to recalibrate the weights.  

Check out the chart below which shows the year-to-date return of the S&P 500, the 7 largest names in the index, and the year-to-date return of the rest of the 493 names in the index. Quite the spread, huh? 

 ^{Source: FactSet, Goldman Sachs Global Investment Research, data as of 09/23/2024. Graph shows Indexed Return of Magnificent 7 Stocks, S&P 500, and remaining 493 companies.}

This is causing some major industry distortions. The Nasdaq 100 Index, which just has the largest 100 companies on that exchange (most technology companies are on the Nasdaq) had to undergo a special rebalance in late July for only the third time in the last fifty-plus years.  

The reason was the need to address over-concentration and avoid breaching certain Securities and Exchange Commission rules on fund diversification. Now, some of the largest investment funds that invest in that index, namely Invesco and Vanguard, are being restricted from buying additional shares of some of these companies.  

Obviously, this is also creating additional risks. Investors are thinking they are taking on less risk by investing in an index fund. It doesn’t take a Chartered Financial Analyst to know that these seven companies have a decent amount in common. That commonality means their correlations are likely very high.  

Going even broader, the top 20 stocks in the S&P 500 are almost entirely made up of technology or ‘communication services’, a relatively new sector that one would say looks a lot like a bunch of technology companies. 

At Noble Wealth, we think this dichotomy between a few larger companies and the “other 493” will close. We are invested in indices that look a bit different than the main index, even investing in ‘equal-weighted” indexes to capitalize on that spread.

Sincerely,

Mark J Asaro, CFA