Asset Allocation
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?”
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.
Market concentration has exceeded levels from the dot-com bubble
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.
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.
Dividend payers and international stocks have shown recent strength
“The market environment had been telling us that only a few U.S. mega-cap companies were worthy of high valuations,” says Gerald Du Manoir, a portfolio manager for CGIE — Capital Group International Equity ETF and EuroPacific Growth Fund®. “Yet there are many companies across industries in international markets with superior businesses, strong reliable cash flows and earnings growth potential. I think investors are starting to recognize a broader range of opportunity.”
For example, German software developer SAP, which was considered to have been left in the dust when U.S. hyperscalers shifted to the cloud, has since made a successful transition to cloud and expanded its business by simplifying its offerings. “The market was skeptical that SAP could execute, but the company succeeded, and its customer adoption rate exploded,” Du Manoir says. “Sometimes it’s the basic things that make a difference.”
Beyond the tech sector, companies like French jet engine maker Safran are tapping into rising global demand for air travel. The company also generates recurring revenue streams through services and maintenance contracts for the engines.
Earnings growth for many tech giants has been robust. But a look across market sectors shows surprisingly strong growth for several, relative to their own histories, some of which include companies with a history of paying dividends. Take utilities, which in the second quarter reported 21% year-over-year earnings growth, the highest growth rate among the 11 sectors in the S&P 500. The S&P 500 Utilities Index, a measure of the largest U.S. utilities companies, gained 21% in 2024 through September 9, outpacing the 14% gain for the S&P 500 and the 19% gain for the S&P 500 Information Technology Index.
Technology isn’t the only sector generating earnings growth
“I think we will continue to see this shift away from a very narrow U.S. stock market,” says Caroline Randall, a portfolio manager for Capital Income Builder®. “I expect investors will increasingly focus on companies tied to long-term growth themes that generate near-term free cash flow and pay dividends. And with the U.S. Federal Reserve planning to cut rates, we may be in the early stages of a renewed focus on dividends.”
For example, U.K. biopharmaceutical company AstraZeneca has invested heavily in research and development to address a wide range of cancers and cardiovascular and renal diseases. The company has a multi-decade track record of paying and increasing regular dividends.
Will today’s tech giants continue to dominate, or will a new group of companies emerge as market leaders? “It would be difficult to discard the potential for today’s tech giants to remain on top,” Stern says. “But in the near term, all these companies are exposed to valuation risk as well as a variety of business risks. That’s why I am seeking balance in my portfolios and looking for opportunities across a broad range of sectors, including technology, health care and industrials.”
For example, within the industrials sector, companies like aerospace components manufacturer and designer TransDigm have sought to tap into soaring global demand for commercial travel. Similarly, GE Aerospace, formerly a conglomerate with interests in media, energy and health care, has reorganized itself to focus on producing jet engines.
After all, the market leaders of today may or may not be those of the future. In fact, a look at the top 10 largest companies by market capitalization at the start of each of the last four decades shows they often posted relatively modest returns in the subsequent 10 years. Are today’s mega-caps destined to fall? “Not necessarily,” says Stern. “But I am focused on discovering the market leaders of tomorrow.”
Hyperscalers are large-scale cloud service providers that offer computing power and storage to organizations and individuals globally.
Past results are not reflective of results in future periods.
The market indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index.
MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization-weighted index designed to measure developed equity market results, excluding the United States and Canada.
MSCI EAFE Growth Index captures large- and mid-cap securities exhibiting overall growth style characteristics across developing markets around the world, excluding the U.S. and Canada.
MSCI EAFE Value Index captures large- and mid-cap securities exhibiting overall value style characteristics across developing markets around the world, excluding the U.S. and Canada.
Russell 1000 Growth Index measures the results of the large-cap growth segment of the U.S. equity universe.
Russell 1000 Value Index measures the performance of large-cap value segment of the U.S. equity universe.
S&P 500 Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks.
S&P 500 Dividend Aristocrats is a stock market index composed of the companies in the S&P 500 Index that have increased their dividends in each of the past 25 consecutive years.
S&P 500 Information Technology Index comprises those companies included in the S&P 500 that are classified as members of the GICS information technology sector.
S&P 500 Utilities Index comprises those companies included in the S&P 500 that are classified as members of the GICS utilities sector.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2024. FTSE Russell is a trading name of certain of the LSE Group companies. FTSE® and Russell® indexes are trademarks of the relevant LSE Group companies and are used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.
©2024 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.
The S&P 500 Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2024 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part is prohibited without written permission of S&P Dow Jones Indices LLC.
Asset Allocation
Market Volatility
Artificial Intelligence
World Markets Review
RELATED INSIGHTS
Asset Allocation
Market Volatility
Get the Capital Ideas newsletter in your inbox every other week