The US stock market has never been more concentrated in a handful of large companies, raising concerns about diversification and potential risks for investors. According to Howard Silverblatt of S&P Dow Jones Indices, just 26 stocks now account for half the entire value of the S&P 500 index, the lowest number since at least 1980. Apollo’s chief economist Torsten Sløk argues that there’s now a “diversification illusion” when buying the S&P 500, as it’s heavily influenced by a few large companies like Nvidia.
Buying the index gives the impression of diversifying across 500 stocks, but the growing concentration means investors are increasingly dependent on the earnings of a small group of companies. Influential investor Chamath Palihapitiya has also raised concerns, noting that this concentration presents risks to average Americans who buy S&P 500 index ETFs for diversification and stability. If the top companies face difficulties, the damage could be severe and widespread.
US stocks now make up a significant portion of global indices, with Apple, Nvidia, and Microsoft alone comprising 13 percent of the $78 trillion MSCI All-Country World Index. The valuations commanded by this small group of super-stocks are also questionable.
Stock market’s concentration dilemma
Goldman Sachs’ David Kostin points out that high concentration increases volatility because the index’s performance depends on a few companies with high valuations, leading to negative risk premiums. The phenomenon is primarily driven by the massive profit growth of mega-cap growth firms over the past decade. The main danger is the risk of overexposure to a single company or sector.
However, many modern US companies are diversified pseudo-conglomerates in practice. If the AI boom fades, the top-heavy US stock market may suffer, and index funds will track this downward trend. However, index funds have historically still outperformed the average active fund manager.
The SPIVA scorecard from S&P Dow Jones shows that since 2004, the majority of professional stock pickers have underperformed their benchmarks. While stock market concentration raises legitimate concerns, the historical performance of passive index funds compared to active management suggests that the issue may not be as dire as some fear. Investors should be aware of the risks but not necessarily abandon index investing altogether.
