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March 2024 Market Update - S&P 500

March 20, 20244 min read

March 20, 2024

Is the S&P 500 Too Highly Concentrated?

With the recent AI-fueled rally, there are now six companies in the US with a $1 trillion plus valuation. To put that into perspective, one billion seconds is roughly 31.7 years while one trillion seconds is just over 31,700 years. Referring to these companies as astronomical would almost be an understatement. Not surprisingly, these companies are largely tech-based:

      Microsoft ($3.1 trillion)

      Apple ($2.7 trillion)

      Nvidia ($2.3 trillion)

      Amazon ($1.8 trillion)

      Alphabet ($1.7 trillion)

      Meta ($1.3 trillion)

As the share prices of these tech behemoths soared in 2023, they began to eat more and more market share. These six companies alone make up 27.5% of the S&P 500. Expanding it to the top 10 holdings, we’re now talking about 33.2% of the Index:

Table 1

Going back to just 2015, the top 10 holdings in the S&P 500 only made up 17.8% of the weight. Needless to say, the most widely followed benchmark in the world has become much more concentrated in recent years.

What does this mean for markets going forward? What if these top companies falter… would it trigger a market meltdown with so much weight in just a handful of stocks?

It’s important to understand how market concentration has fluctuated throughout history. From 1950 - 1970, it was common for the top 10 holdings to make up more than a third of the S&P’s total market cap. The top 10 accounted for over 40% of the S&P 500 in the early 70s before starting a trend lower. Concentration remained more muted in the 80s and 90s, averaging below 20%, but spiked higher again leading up to the dot-com-bubble.

Over this period of time, the S&P 500 has still averaged a solid 11.28% average annual return amid these market concentration shifts. It’s normal for different companies to ebb and flow into and out of the top 10. The majority of today’s top holdings didn’t even exist back in 1950, but the market continued to grow and expand. The largest companies tend to represent the trends and preferences of the times.

Using the late 1990s as a proxy for today, large tech-focused companies were dominating the markets, with the top 10 holdings making up a quarter of the S&P 500. This was great when markets were firing on all cylinders. Just look at the returns in the last half of the decade.

Table 2

Not a bad five year stretch there. The data above also shows that strong trends with bubble-like characteristics can last for much longer than most investors think. However, the good times didn’t last forever. When the dot-com bubble popped, the S&P 500 saw three consecutive losing years, with large-cap tech companies leading the way lower.

Table 3

This doesn’t necessarily mean we’ll see the exact same scenario play out in the 2020s. There are plenty of differences, for the better, when comparing today's environment to the dot-com era. For example, the tech companies in question today are more profitable and cash-heavy than the companies of the early 2000s.

Nonetheless, market trends can change direction quickly, without much notice. This is why maintaining a diversified portfolio can be so important. It can be tempting to chase trends as they happen in real time, but patience can pay off over the long-run. Just look at how some of these non-tech market categories held up during the dot-com bubble.

Table 4

While large-cap tech companies were being pummeled, a diversified portfolio would have held up much better. This is even true in more recent history. During the bear market of 2022, we saw sharp losses in these mega-cap companies - Alphabet (38.67%), Amazon (49.50%), Apple (26.31%), Meta (64.22%), Microsoft (28.02%), and Nvidia (50.26%). Compared to the 18.11% loss for the S&P 500, each of these stocks was far worse than the Index. As these big name tech companies faltered, other sectors stepped up to help offset the losses.

Diversification isn’t about maximizing returns in any given year. It’s more about risk management and regret minimization. Market trends tend to work like a pendulum, swinging from one side to the other as investors try to find the appropriate equilibrium. There’s no way to know exactly what comes next, but holding various asset classes can help insulate against concentration risk, while still providing some exposure to whatever’s working at the time.

Remember, if your investments feel too exciting then you might be gambling, not investing. Successful investing should be boring, with different asset classes working together to achieve an appropriate balance over a long-term time horizon.

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