Still on Top
The US stock market experienced another strong quarter, though its underlying components varied considerably. For example, the tech-heavy NASDAQ rose over 8% while the more balanced Dow Jones index declined by 1%. This divergent movement has contributed to increased concentration within the US stock market. As of June 18, the 30 largest stocks in the S&P 500 had a combined weighting of roughly 53% of the index. The last time we reached these heights was twenty-five years ago near the peak of the dot-com bubble when the 30 largest stocks made up 42% of the index. Interestingly, only 10 of the 30 largest companies today were also in the top 30 in 1999.
Most broadly followed stock indices are market-cap weighted, meaning the larger an individual company grows relative to other companies, the larger the proportion of the index it makes up. The recent increase in market concentration has been driven by numerous factors, including rapid technological advancement, economic and market conditions pushing investors toward larger companies, and stock index fund weightings. As an ever-growing amount of money invested in funds that track stock indices, more dollars are funneled toward those large companies.
High market concentration isn’t without risks. When few companies disproportionately affect the overall market, it can lead to increased volatility. Similarly, the financial health and performance of these few large companies become crucial for the market, potentially increasing risks if they face significant or unexpected issues.
Mutual funds and exchange-traded funds (ETFs) are the most common vehicles used to invest in financial markets. These products can be managed passively, meaning they are designed to match the holdings and performance of a market index, such as the S&P 500. Alternatively, they can be managed actively, where managers are employed to achieve certain objectives; commonly, this involves attempting to outperform their respective index, but it could also involve managing toward specific risk metrics, dividend/income targets, or other goals.
Historically, the optimal strategy to employ has varied depending on the sector of the market and broader economic conditions, including market concentration. When markets are becoming more concentrated, that environment has favored passive funds. Conversely, when market breadth increases and concentration decreases, that has historically favored active funds. This is a key reason why we typically utilize both types of holdings: core exposure to the markets through extremely low-cost passive investments, complemented with active or factor-weighted funds. In the same way that diversification across different asset classes can help to lower risk and improve long-term results, diversifying underlying management styles can also provide benefits. It’s impossible to know how market concentration will ebb and flow in the future; maintaining a well-rounded and flexible investment approach can help to manage risks and capitalize on opportunities as they arise.
Wishing you a wonderful Fourth of July!
The PWM Team
