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Dispatches Economic and Market Analysis

The Implications of High Concentration in the S&P 500

Concentration tells you how much of an index’s or portfolio’s returns are influenced by its largest positions.

by Charles Rotblut | July 2024

Charles Rotblut leads a class in AAII's new Essential Investing Video Course. Go to https://www.aaii.com/ves for more information and to subscribe.

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“When it comes to measures of the market, May’s elephant in the room is concentration ... At the end of May, weights of the top-10 largest constituents in the S&P 500 summed to 34%,” observed S&P Dow Jones Indices in its May 2024 Factor Indices dashboard report.

Concentration tells you how much of an index’s or portfolio’s returns are influenced by its largest positions. Microsoft Corp. (MSFT) accounted for 6.96% of the S&P 500 index’s total market capitalization at the end of May 2024, followed by Apple Inc. (AAPL) at 6.30% and Nvidia Corp. (NVDA) at 6.11%. Put another way, three stocks accounted for nearly one-fifth of the S&P 500’s market value and thereby performance.

High levels of concentration have occurred before. Michael Mauboussin and Dan Callahan, CFA, of Morgan Stanley point out that the 10 largest stocks accounted for about 30% of the U.S. stock market’s capitalization at the end of 1963 (“Stock Market Concentration: How Much Is Too Much?,” June 4, 2024). The 10 largest stocks accounted for 38% of the market in 1900. (There were fewer stocks traded in 1900, though.)

Concentration of 10 Largest Stocks in the S&P 500

The primary risk of high concentration is that if the largest stocks stumble, the index’s returns will fall too. Large-cap and multi-cap mutual funds and exchange-traded funds (ETFs) will also be hurt.

Investors have a few options. One is to stay the course and continue to hold market-cap-weighted funds like the Vanguard 500 Index Admiral fund (VFIAX) or the iShares Core S&P 500 ETF (IVV). A second is to use equal-weight funds like the Invesco S&P 500 Equal Weight ETF (RSP). This ETF holds the same stocks as the two funds previously mentioned but weights them equally instead proportionately by market cap.

A third option is to focus on stocks providing exposure to factors associated with shareholder friendliness. S&P Dow Jones Indices found that portfolios targeting large-cap stocks engaged in buybacks outperformed the S&P 500 by approximately 10% during the 12 months following a peak in concentration. High dividend yields were a strong second-place finisher with about 8% outperformance. (Dividend strategies overall did well.) Equal-weighting and value strategies also delivered excess performance.

A fourth option is to scale down in size. Small-cap stocks continue to trade at historically large discounts relative to large-cap stocks.

Discussion

BARRY J from TX posted over 2 years ago:

Charles, the SPX concentration chart in this article provides some useful observations on historical SPX concentration cycle timing, trends, and length. From May 1994 concentration rose 10% over 6 years during the “internet boom” until May 2000, when the internet bubble began to burst. Then SPX concentration reverted back toward the mean down about 10% over 16 years through May 2016 when the current trend of increasing SPX concentration began and rose about 15% over the 8 years through May 2024. You presented (I counted 7) options on how to prepare for an eventual mean reversion in SPX concentration – of unknown timing and length. The last two options – value stocks and small caps -- appear (to me) as the highest most likely beneficiaries of a concentration reversion. SPX DJI’s “May’s elephant” in the room looks more like a python that swallowed a pig – that bulge is going take time to digest so that python (that is my metaphor for SPX) is going to be asleep for a while more. The SPX “python” swallowed the AI “pig” around 2010 [https://en.wikipedia.org/wiki/AI_boom]. The current “pig in a python” effect continues to distort the distribution of SPX returns is in its 14th year. The Top 10 are 34% of the SPX index value; the “Other 490” of the US LARGEST companies provide 66% of total market value. The ratios of these averages are 3.5% to 0.13% which creates a Top10 to Other 490 1:49 ratio AND a ratio of average returns YTD @27:1. With these data points, we can estimate the skewedness around the peak point (which is above the true mean) larger than 1 SD. Benchmarks become worthless as measures if they are skewed. So, I am measuring my YTD returns verses Equal-Weight SPX returns this year since all the ETFs I hold are benchmarked against the SPX. A reversion to the mean concentration may be the opportunity to move money into “non zombie” mid-caps and small caps, companies with good fundamental balance sheet ratios and enough free-cash-flow to cover debt service and growth investment requirements that provides access to lower rates after the Fed FFR lowers as expected. Here’s hoping we get good news in the second half. #1 The Fed is hinting at least one FFR cut in Sep or/and Dec. #2 The Aug-Nov Election cycle will reveal candidates’ fiscal policy priorities. #3 In Oct-Dec, we enter the historical “good” half of the Calendar cycle. #4 We may get a Santa Claus rally through New Year.


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