Should we be worried about a concentrated US sharemarket?

One of the biggest talking points for investors in the past year or two has been the increasingly concentrated nature of the US sharemarket.

The three largest companies in the S&P 500 index – NVIDIA, Apple and Microsoft – have gotten so big they account for close to a fifth of the index.

The top ten (which also includes the likes of Amazon, Meta and Alphabet) represent a whopping 38 per cent of the index today.

Over the past 50 years that’s been closer to 20-30 per cent.

Unsurprisingly, this has made a lot of investors nervous.

If you prefer to listen to a podcast episode on this topic: 

A few mega-cap stocks now have a huge influence over where the world’s biggest market (and therefore most of our retirement savings) is headed.

However, this isn’t completely new.

The performance of sharemarkets has always been dominated by a small group of big winners.

One of the most famous studies in financial academia was released in 2018 by Professor Hendrik Bessembinder of Arizona State University.

It’s also one of the most relevant and hard-hitting for regular investors like you and me.

Titled “Do stocks outperform Treasury bills?”, Bessembinder examined the lifetime returns (including reinvested dividends) of every stock traded in the US since 1926.

Treasury bills are a very low risk short-term deposit with the US Government, and they’ve delivered about 3-4 per cent annually over the past 100 years.

In contrast, US shares have performed much better with annual returns of more than 10 per cent over the same period.

However, that’s in aggregate and as a group.

Bessembinder was more interested in how many stocks had beaten that Treasury bill return on an individual basis.

His findings were staggeringly blunt, with the analysis showing that most stocks don’t do very well at all.

There were more than 25,000 companies covered in his database and the median “lifetime” was seven-and-a-half years.

More than half delivered negative returns over that period, some went to zero, while only four out of ten proved better than simply sitting on the sideline in Treasury bills.

With that in mind, how on earth has “the market” performed as well as it has over the long-term?

Here’s the crux of it.

The typical stock ends up being a disappointment, but there’s a minority of superstars that make the whole system look great.

This was the key point Bessembinder concluded in his study.

He found that the entire net gain from US shares over the 90 years he looked at came from just four per cent of companies.

The other 96 per cent collectively matched the return of cash, and investors didn’t get compensated for the additional risk they took by owning them.

The sharemarket is far from a level playing field where most stocks truck along at a similar pace.

It’s a giant winner-takes-all machine where a small group of companies end up dominating proceedings and delivering most of the gains.

We’ve seen this across multiple eras, whether it’s railroads, oil giants, the internet leaders of the 1990s, or the tech and AI behemoths of more recent years.

While the influence of superstar stocks on returns isn’t new, today’s market concentration is unusually extreme.

We shouldn’t ignore that.

Current trends can’t continue forever, and there’s surely a limit to how large and dominant the biggest companies can become.

At some point investors will start to question the structure of the market, while regulators might pay increasingly more interest too.

Today’s heavy hitters could eventually face competitive pressures or other challenges, just as their predecessors did.

Exxon Mobil was the biggest stock in 2010, General Electric a decade earlier and IBM ten years before that.

Those comparisons seem foolish given how strong the heroes of today are, but who knows where we’ll be in 2035.

The most important message for the everyday share investor is that diversification is essential, not optional.

Sharemarkets have performed fantastically well over the long-term, but there tends to be a small group of big winners driving that growth.

Picking which ones those will be for the next year or the next decade is incredibly difficult, and if you miss those it will be costly.

The market has always been inherently uneven.

A few stocks will surge, many will struggle and some will disappear. Concentration is part of the investment landscape, and we need to understand it rather than fear it.

Market Insights enewsletter

Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.

Subscribe Now