Has stock market concentration reached a tipping point?

Hyperconcentration in the U.S. stock market may be nearing a peak.

Against a backdrop of disappointing economic news, stock market volatility has flared in recent weeks, and AI-focused tech titans have sustained some of the sharpest declines. Days after reporting robust earnings growth, semiconductor giant Nvidia plummeted 14% in a week, resulting in a $406 billion loss in market value, the largest weekly loss in dollars for any company in history. Microsoft, Meta Platforms and Alphabet have also seen their shares swing from gains to losses since early August.

The jump in volatility follows an extended period of dominance for the Magnificent Seven, a group of mega-cap tech companies, six of which have businesses connected to AI. Since the start of 2023, four of these companies — Nvidia, Microsoft, Alphabet and Meta — have accounted for 43% of the total U.S. market return as of June 30, 2024.

Whether news was good or bad, share prices for these companies only seemed to climb. Now one disappointing unemployment report can trigger sharp declines. “The sudden change in sentiment poses an important question for investors,” says Eric Stern, a portfolio manager with The Growth Fund of America®. “Is a shift in market leadership going to become the dominant theme in the years ahead? Or will the Magnificent Seven stocks continue to generate the lion’s share of returns?”

High market concentration poses risks

Even after accounting for the summer volatility, market concentration in the S&P 500 Index remains at stratospheric levels. The 10 largest companies in the S&P 500 (which include the aforementioned tech giants) accounted for a stunning 34.2% of the total market capitalization of the index as of August 31, 2024.

Investors may be surprised to learn today’s market concentration is considerably higher than the peak of the dot-com bubble in 2000. But any comparisons of today’s market leaders with those of the tech bubble in 1999 must be viewed in context. Although elevated, valuations for today’s tech giants are considerably lower than those of the previous period and supported by strong earnings growth. For example, Nvidia’s profit more than doubled from a year earlier to $16.6 billion for the quarter ended July 31.

That said, high concentration can increase risk for investor portfolios. Today’s tech frontrunners can be vulnerable to regulatory risks, technological disruptions and the possibility that the path to AI profitability may be longer than expected.

“There is also some circularity to the Magnificent Seven earnings growth, because to some degree they are funding each other,” Stern says. Indeed, about half of Nvidia’s revenue in its latest quarter came from four companies.

Early signs of market rotation emerge

Even before the sharp market selloff in early August, there were signs of broadening market participation. A look at key style and geographic indexes shows that thus far in the third quarter, dividend payers, value companies and international equities all outpaced the broad S&P 500. And the MSCI EAFE Index, a broad measure of international stock markets, is far less concentrated than the U.S. market.