By Tim Courtney, Chief Investment Officer
Amid the pandemic, inflation and widespread supply chain issues, one development that has started to receive more attention is the increasing concentration of the S&P 500. While this began years ago, it accelerated in 2020, and today the 10 largest companies in the S&P now represent about 30% of the entire index.1
That’s the highest percentage ever recorded, edging past the 27% figure at the height of the tech bubble in 2000, as well as the 28% seen during the 1970s when companies like Polaroid and Kodak were disrupting the economy.1 The current figure is even more noteworthy because the top 10 companies in the S&P composed only 16% of the index’s market cap as recently as 2015.1
Why has there been such a great leap in so short a time period? The answer is that the largest names have recorded immense cash flows and profit margins in recent years. Apple became the first $1 trillion company in 2018, and since then, Microsoft, Alphabet, Amazon and Facebook have all eclipsed that magic number as well.2 As a result, investors who invest in the S&P 500 index have been purchasing more and more of these big names as they’ve grown ever larger.
That creates a situation investors should be aware of for a few reasons. First, when companies become so large, it becomes harder to maintain the impressive growth that got them there. They’ve reached great profitability due to growing demand for their products or services, but history has shown that the growth doesn’t continue in a parabolic fashion. Second, consumer preferences can change, and these companies will need to continue innovating in a very competitive marketplace to keep their edge over others trying to dethrone them.
A third headwind, which we’ve seen over the past several months, is regulatory risk. The word “monopoly” is often used when these companies are discussed in the news and at the congressional hearings in which we’ve seen their CEOs testifying.3 That combination may be leading to actual dislike among consumers, which goes beyond simply evolving preferences. In fact, a recent Gallup poll measuring how much people trust institutions showed that big business ranked third-worst, while small business topped the list.4
From an investing standpoint, what does it mean when indexes are buying more and more of fewer companies? Historically, the largest names on average have outperformed on their way to the top 10 and then have on average underperformed the broad market over the next decade.5
This is not to say investors shouldn’t own these names. We recognize these companies are very successful and should be part of a diversified portfolio. Some of these companies may continue to outperform. This begs the question, should we own these names at higher and higher weights? Considering the history of markets and in order to better manage the risks noted above, we believe it is prudent to hold these names at lower weights and concentrations than market cap indexes do.
We believe it is important to own well-diversified portfolios of productive companies without placing too much emphasis on their size. Circumstances tend to change, and having less concentration in portfolios is a risk management strategy for when they do.
Sources:
- ETF Trends (8/23/20) — This S&P 500 metric is at its highest level ever: What can investors do?
2. Visual Capitalist (8/23/21) — Which companies belong to the elite trillion-dollar club?
3. NPR (3/25/21) — 5 takeaways from big tech’s misinformation hearing
4. Gallup (7/14/21) — Americans’ confidence in major U.S. institutions dips
5. Dimensional (12/31/20) — Using data from CRSP, the largest stocks identified at the end of each calendar year by market capitalization. Market is the Fama/French Total US Market Research Index.
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
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