By Ben Carlson, originally published at A Wealth of Common Sense.
The top 10 stocks in the S&P 500 make up almost 40% of the index.
Each of the companies in the top 10 sport a market cap of $1 trillion or more. In fact, as of this writing, the 12 biggest companies all have market caps of $1 trillion or more.1
As recently at 2015, the top 10 made up just 17% of the S&P 500.
This feels like a scary proposition for index investors because it feels like the fate of your performance can be determined by a small subset of companies.
What if these huge companies in the top 10 get crushed? Will it bring the entire index down?
I understand the concern but there are a few things you need to understand about stock market concentration.
1. Stock market concentration is a bull market phenomenon. Michael Mauboussin and Dan Callahan found that S&P 500 returns were above average when concentration in the index was rising and below average when it was falling:
I first wrote about concentration worries all the way back in 2018. The market has only become more concentrated since then. And we’ve been in a raging bull market.
Coincidence?
I think not.
2. The rest of the world is even worse. Michael Cembalest has a good chart that shows the concentration of the top 10 names in stock markets around the globe:
There are only two stock markets with less concentration than the United States — Japan and India. Everywhere else the concentration in the top 10 names is way higher.
Take South Korea as an example of this extreme concentration. The top 10 make up around 80% of the total market cap. But just two stocks make up almost 50% of the entire stock market.
3. The fundamentals back it up. JP Morgan has a chart that shows the ever increasing concentration in the S&P 500 by market cap but also compares it to the share of earnings coming from the biggest names:
The top 10 make up almost 40% of the index by market cap and the share of earnings. The market cap weights make sense relative to the fundamentals.
In many ways, the stock market mirrors the rest of the economy. Household wealth is even more concentrated than the stock market.
The top 10% control two thirds of the wealth in America and own 87% of the stock market.
The extreme views on AI is that it’s either going to make inequality even worse or level the playing field.
Bill Gates recently wrote, “In terms of equity, AI will either be the greatest equalizer ever invented, or the worst source of injustice.”
Once SpaceX, OpenAI and Anthropic enter the S&P 500 there will be an even bigger cohort of large tech companies at the top.
The wealth that will be created for the employees and investors in these companies is staggering in such a short period of time.
There’s a good case to be made that AI will flatten the world in terms of creating more opportunities for learning and starting businesses. Maybe it will be a great equalizer.
But it also seems like the current system is one in which concentration is a natural outcome.
Even if AI makes the pie grow bigger, it feels like a better bet that it will only increase the level of concentration in the stock market and economy if the past is a good predictor of the future.
Further Reading:
The New Normal of Stock Market Concentration
1Berkshire Hathaway and Eli Lily are now in the four comma club too.
Ben Carlson writes at A Wealth of Common Sense. Read this article on their site.
