Is the US Stock Market Too Concentrated? A Global Perspective

Is the Dominance of the “Magnificent Seven” a Cause for Concern? We explore the data and its implications for investors.

Is the US Stock Market Too Concentrated? A Global Comparison

The US stock market appears to be experiencing a period of high concentration, with the S&P 500’s top 10 companies holding a significant share of the index. This phenomenon, often attributed to the dominance of large tech companies, has sparked concerns about market stability and diversification.

However, a recent study by Dimson, Marsh, and Staunton, published in the Global Investment Returns Yearbook, reveals a surprising finding: the US market, while experiencing concentration, is actually less concentrated than many other major markets.

The study, spanning over a century of investment returns, analyzes markets worldwide and concludes that the US market boasts higher diversity compared to its global counterparts. Notably, only Japan displays a lower level of concentration in its leading companies.

This finding suggests that while the US market’s concentration is worth monitoring, it’s crucial to consider the global context when assessing the potential implications.

Avoiding Big Tech? Stock Market Concentration is Higher Outside the US

Worried about the dominance of the “Magnificent Seven” tech giants in the US stock market? You might be surprised to learn that market concentration is even higher in many other countries. This means that seeking diversification outside the US might not be the solution you expect.

For example, Italy’s FTSE-MIB index has its top 10 stocks accounting for a staggering 72.8% of the index, with Unicredit SpA alone making up 11.04%. In France, the CAC 40 index has luxury giant LVMH Moet Hennessy Louis Vuitton SE claiming a sizeable 11.67% share.

These figures suggest that if you’re concerned about concentration, Japan or more diverse markets may be better alternatives to simply avoiding the US.

Is US Stock Market Dominance a Reason to Diversify Globally?

While national stock indexes can highlight market concentration, they may not be the best lens for global investment decisions. MSCI’s international indexes, widely used by asset allocators, paint a different picture.

The top 10 companies represent a much smaller portion of these indexes: 23.1% of the MSCI Emerging Markets and 15.3% of the MSCI EAFE (covering non-US developed markets).

This suggests that asset allocators often focus on the decision between the S&P 500 and these MSCI indexes as a diversification strategy. The increasing global concentration in the US market might be a key driver for this approach.

US Market Dominance: Boon or Bane for Investors?

The US stock market has reigned supreme for over a century, with a brief exception during the Japanese bubble in the late 1980s. Its current dominance, reaching 61% of global market cap, marks a high since the 1960s. While this dominance coincides with increased global market concentration, it’s crucial to note that shunning the US market has historically led to missing out on significant returns.

However, the question remains: is concentration inherently bad? While not necessarily detrimental, it can indicate an unbalanced economy. Emerging markets often display dominance in specific industries, and the US was historically an exception. While technology is currently a leading sector, its influence pales in comparison to the railroad industry’s dominance during the country’s earlier stages of development.

Tech Dominance in the US Market: Cause for Concern?

The increasing reliance of the US market on the technology sector raises questions about its long-term stability. While not necessarily alarming, this trend suggests a potential for economic imbalance. Additionally, the dominance of tech giants may siphon profits away from other sectors, further fueling this concentration.

This concentration poses challenges for investors. Actively-managed funds often struggle to outperform heavily-concentrated indexes. As Patrick Palfrey of UBS notes, large-cap managers generally underweight the market’s biggest stocks, leading to a difficult choice: underweighting the high-performing tech sector can lead to underperformance, while overemphasizing it sacrifices diversification.

Should Investors Rethink Benchmarking and Diversify Beyond the US?

Traditional benchmarking practices, where active fund managers are compared against specific indexes, can be problematic. This comparison encourages herding behavior around the index, potentially limiting outperformance. Here are two potential solutions:

1. Abandon Benchmarking: Eliminating the focus on tightly defined indexes may encourage managers to pursue more differentiated investment strategies, potentially improving investor outcomes.
2. Embrace Global Diversification: Focusing on broad international indexes, rather than heavily publicized national indexes, can help investors diversify beyond the US market. This strategy can mitigate concentration risk and potentially expose investors to untapped opportunities.