Is the S&P500 Too Concentrated?

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In Clearwater Capital Partner’s Outlook 2024, it was highlighted that most of the performance in the S&P 500 last year could be attributed to seven stocks (AMZN, AAPL, GOOGL, META, MSFT, NVDA, and TSLA). This trend of concentration has continued so far into 2024 as the 10 largest positions in the index make up 33% of the market value according to a Goldman Sachs article, published on March 21. Market concentration has begun to garner a lot of attention amongst investors and pundits.   How rare is this phenomenon? The recent rise in concentration is the steepest in 60 years, and the relative market cap share of the largest stocks is at the 86th percentile when compared to the history of the index, a JP Morgan study showed.


How did we get here? It’s no coincidence that this move occurred during a shift in Fed policy from near zero interest rates into an aggressive rate hiking cycle to fight inflation. Higher Fed Funds rates ultimately force discount rates higher, driving prices down for cyclical growth stocks and more speculative companies with longer time horizons to earnings growth. As a part of a “flight to safety” trade, Investors have rotated into the larger Technology and Communication Services companies with more stable cash flows and proven growth.

While these companies continue to attract capital flows, they also continue to produce strong operating margins and return on equity. The chart above demonstrates that although the concentration of the Top 10 stocks is higher than that of the “dot-com bubble,” the EPS is now well above where it was during that period, keeping valuations at far more attractive level relative to the 2000s (Goldman #2). Additionally, Artificial Intelligence has been a speculative growth prospect that has seemed to gain momentum and push through the headwinds of the aforementioned higher discount rates further fueling the growth in Mega-cap’s market share.  “The large capital investments required to build out AI and LLM infrastructure favor the largest multinationals. These companies should continue to win market share from smaller players due to massive economies of scale and their global footprint,” Dubravko Lakos-Bujas of JPM explains.

So, where do we go from here? Will concentration get worse or better? These companies have continued to grow at exceptional rates for their size. While popularity and momentum may be a contributor to the pace of growth, it’s not without merit. The Magnificent 7 contributed to a majority of the earnings growth in the index last year and it looks to do the same this year with a projected EPS growth of 28% in 2024 vs the S&P projection of 9% (Seeking Alpha #4). The stock market is a predictive mechanism, however, and it could be argued that much of that out-performance in earnings expected for this year was a large contributing factor to the gain in market share last year. The risk/reward picture for these positions has become tighter as expectations have gone from sky high to outer space for these companies. Goldman Sachs argues that to maintain this outperformance the 7 need to focus on hitting a “3-year CAGR sales growth of 12% vs 3% for
the S&P 493” (Goldman #5).

One should also consider the Fed policy that aided the recent increase in concentration. The graph above shows how an inverse relationship has developed between money supply growth and concentration levels since 2009 (JP Morgan #3). If the Fed begins unwinding the hawkish policy and begin cutting rates (increasing the money supply) it could contribute to a reduction of market concentration. Alternatively, if inflation continues to be an issue and the money supply continues to contract, the concentration could grow.


I would caution one to conclude that a reversal of the concentration in the market automatically indicates a recession. In fact, a State Street article recently demonstrated that market concentration has little to no effectiveness in predicting future returns over a subsequent 6 or 12 month period. And while past performance is no indication of future returns, it is intriguing to consider that in the 12-months following the seven other periods of “extreme concentration,” two resulted in market drawdowns (1973 and 2000) and five in market rallies with average returns higher than 23% (1932, 1939, 1964, 2009, and 2020) (Reuters #7).

However, with such a small sample size it again becomes difficult to directly draw conclusions one way or another. What should be considered is how to position yourself for a range of outcomes. The chart above demonstrates how the Top 10 largest US companies can continue to provide positive returns on average but may begin underperforming relative to the market over longer periods of time (Goldman #8). At CCP, we deploy factor-based methodologies that weigh stocks based on quality, value, momentum, size, etc. factors as a part of our Strategic Asset Management (CCP #9). This process helps to diversification beyond the market-cap weighted S&P 500, which can be critical in these environments.