Is The US Stock Market Too Concentrated?

I
disagree.
Even
investors
who
own
only
a
US
equity
index
fund
hold
more
than
70%
of
their
assets
outside
of
the
“Magnificent
Seven”
stocks,
which
are
Alphabet (GOOGL),
Amazon.com (AMZN),
Apple (AAPL), Meta
Platforms (META),
Microsoft (MSFT),
Nvidia (NVDA),
and
Tesla (TSLA).

And
such
pension
participants
are
rare. Vanguard
reports that
only
1.3%
of
its
401(k)
plan
participants
invest
in
a
lone
equity
fund.
The
other
88.7%
own
either
multiple
funds
or
a
target
date
fund.

The
chart
below
displays
the
Magnificent
Seven’s
weighting
in
four
Vanguard
funds:
1)
500
Index
(VFIAX);
Total
Stock
Market
Index
(VTSAX),
Target
Retirement
2055 VFFVX,
and
4)
Target
Retirement
2025
(VTTVX).
Whether
the
first
two
funds
have
too
much
money
in
too
few
securities
can
be
debated.
The
latter
two,
though,
are
relatively
safe –
and
they
are
far
more
typical
of
401(k)
pension
accounts.

(Although
Target
2055
invests
90%
of
its
assets
in
equities,
its
Magnificent
Seven
exposure
is
greatly
reduced
because
of
the
fund’s
overseas
holdings.
The
same
principle
applies
to
other
target-date
series,
as
all diversify
internationally.)

Bigger
Now

That
said,
the
concern
about
overconcentration
must
have some basis.
Otherwise,
why
has
the
assumption
become
so
prevalent?
To
assess
the
proposition,
I
evaluated
the
distribution
of
corporate
profitability.
Specifically,
I
took
the
profits
generated
by
1)
that
year’s
highest-earning
firm,
2)
the
five
highest-earning
businesses,
and
3)
the
10
highest-earning
companies,
then
divided
those
totals
by
the
summed
earnings
of
the
100
highest-earning
US
companies.
The
results
for
2013,
2018,
and
2023
appear
below.

Profit
Concentration:
Recent
History

The
people
are
correct.
In
10
years,
the
profit
share
from
the
five
largest
companies
spiked
from
18.9%
to
30.7%,
while
that
for
the
top
10
firms
increased
from
31.8%
to
43.4%.
Without
question,
the
leaders
have
strengthened
their
positions.

But
Even
Bigger
Then

This,
however,
is
merely
the
current
view.

I
hoped
to
place
it
in
perspective
by
considering
the
longer
history –
back
to
the
1950s,
if
possible.
To
my
delight,
I
managed
to
track
down
the
relevant
information.
Although
Morningstar’s
equity
database
does
not
date
back
that
far,
an
archived
list
of
Fortune
500
members,
published
by
CNN,
did
the
trick.
That
source
provides
the
earnings
for
each
Fortune
500
constituent,
from
1955
through
2005.
Here
is
a sample.

Copying,
pasting,
and
calculating
the
relevant
percentages
for
each
year
is
beyond
the
call
of
an
internet
columnist’s
duty,
but
I
did
conduct
the
task
for
each
half-decade
from
1958
through
2023
(with
the
post-2005
results
obtained
through
Morningstar
Direct.)

As
before,
I
measured
the
percentage
of
the
total
profits
recorded
by
the
country’s
100
highest-earning
firms
that
came
from
the
year’s
single
most
profitable
company,
its
five
most
profitable,
and
its
10
most
profitable.

Profit
Concentration:
Longer
History

That
picture
tells
a
very
different
story.
Over
the
past
30
years,
the
leading
companies
have
indeed
consolidated
their
power.
Once
dozens
of
organisations
competed
in
the
primary
technology
battlegrounds:
mainframe
computers,
personal
computers,
and
software.
Not
anymore.
These
days,
the
biggest
organizations
have
pushed
their
rivals
to
the
margins.
For
example,
Apple
and
Samsung
(SMSN)
jointly
own
more
than
half
the
global
smartphone
marketplace.

This,
however,
is
not
the
first
time
that
the
leading
businesses
have
been
so
powerful.
As
the
chart
indicates,
we
have
been
to
this
place
before –
and
then
some.
To
be
sure,
the
names
and
industries
were
dissimilar.
In
1963,
when
the
10
most
successful
businesses
booked
51%
of
the
top
100′s
profits,
the
winners
consisted
of
five
oil
companies,
two
auto
manufacturers,
two
conglomerates,
and
a
lone
technology
provider,
IBM
(IBM).
None
of
the
companies
cracks
the
current
list.

Intuitively,
that
American
industry
was
once
even
more
top-heavy
than
it
is
today
makes
sense.
Although
few
of
us
directly
experienced
the
stock
markets
of
the
1950s,
we
can
likely
recall
the
adage
that
what
was
good
for
General
Motors
(GM) – and
before
that,
US
Steel
–was
good
for
the
country.
Big
business
was
fashionable.
Three
companies
controlled
94%
of
the
vast
domestic
automobile
market.
DuPont
(DD) employed
more
chemists
than
did
all
American
universities,
combined.
And
Ma
Bell,
of
course,
managed
every
telephone
line.

The
Bottom
Line:
Investment
Risk

Despite
the
presence
of
those
giants,
which
dominated
stock
market
capitalisation
even
more
than
they
did
profitability –
in
the
late
1950s,
three
stocks
accounted
for
almost
30%
of
the
S&P’s
value –
that
era
is
not
remembered
for
its
stock
market
volatility.
Which
leads
to
the
question:
are
narrow
marketplaces
riskier?
Such
is
certainly
the
common
belief.
But
rarely
is
it
tested.

Now
is
the
time.
The
next
chart
plots
the
profit
percentage
of
the
five
highest-earning
companies
(again,
divided
by
the
profits
of
the
100
highest-earning
firms)
in
blue
against
the
future
five-year
standard
deviation
of
the
stock
market
in
red.
Yes,
the
graph
is
messy.
But
its
conclusion
is
simple:
To
the
extent
that
a
relationship
between
the
two
factors
exists,
it
seems
to
be
negative.
That
is,
the
higher
the
profit
percentage
for
the
top
five
holdings,
the
lower
the
market’s
volatility.

Portfolio
Concentration
&
Stock
Market
Risk

I
do
not
believe
that
finding
is
meaningful.
Rather,
it
is
an
accidental
link
that
suggests
that
concentration
is
only
tangentially
related
to
stock
market
risk.
Inflation,
recession,
and
the
aftereffects
of
speculation
(as
with
the
2000-02
downturn)
matter
a
lot.
Whether
corporate
wealth
is
spread
thinly
or
broadly,
not
so
much.

Note:
This
article
was
inspired
by
a
blog
from
Acadian
Asset
Management
by
Owen
Lamont,
called Magnificent
Ignorance
About
the
Magnificent
Seven.
As
you
will
see
if
you
read
it,
the
material
in
this
column
is
my
own.
But
the
initial
idea
came
from
elsewhere.

Correction:
In
a
previous
version
of
this
article,
the
math
behind
evaluating
the
distribution
of
corporate
profitability
was
reversed.
This
has
been
corrected.

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