Market Concentration: What’s really going on

If you’ve been following financial news lately, you’ve probably seen the headlines warning that the top 10 stocks now make up a larger share of major stock market indices than ever before. Most of these are technology and AI-driven companies, and if these giants stumble, the thinking goes, so will your portfolio.

It’s a reasonable concern that we take seriously, but before rushing to make changes, it’s worth examining what’s actually happening beneath the surface.

These are not really 10 companies

These aren’t single businesses. They’re conglomerates containing dozens of world-class operations that could easily stand alone as publicly listed companies.

Similarly, its Mac division, iPad division, and Wearables division would each rank among the world’s largest technology companies if listed separately.

The same applies across the top 10. YouTube, buried inside Alphabet, generates $54 billion in revenue and would likely make it one of the 20 largest companies in the world. Amazon’s AWS cloud division crossed $100 billion in revenue last year. Microsoft contains Azure, LinkedIn, Xbox, and Office 365, each generating billions independently.

The “top 10 concentration” is partly an illusion of corporate structure. If these companies reorganised into their component parts, the index would look far more diversified overnight, without any change in the underlying businesses you actually own.

Concentration Isn’t New

Market leadership has always been concentrated. In the 1980s, it was oil companies and industrials. In 2000, it was the dot-com darlings, many of which no longer exist. The names at the top constantly change, but there’s always a top 10 dominating returns.

What’s different today is that these leaders have earned their position through actual revenue and profits, not speculation. The earnings generated by these companies justify much of their market weight. They sell real products to billions of real customers every day. This doesn’t guarantee future success, but it’s a more solid foundation than we’ve seen in previous concentration cycles.

Markets change over time

The companies dominating an index today may not be the same companies dominating it in the future. In a market-capitalisation-weighted index, a company’s weighting will naturally rise or fall as its market value changes. Over time, new businesses can enter an index while others become smaller constituents or leave altogether.

The practical question

Even if concentration does lead to higher risk or lower returns ahead, what’s the alternative? Trying to predict which companies will decline? Moving to cash? Every alternative carries its own risks and usually involves speculation about an unknowable future.

We understand the concern, but when we look beneath the headlines, we find reasons for continued confidence in a diversified, long-term approach.

For someone investing over many years, today’s market concentration is just one of many factors that could influence future outcomes. What leads markets ten or twenty years from now may look very different from what leads them today. For long-term investors, broad diversification can help reduce reliance on the fortunes of any single company, sector or market.

As always, we’re here if you’d like to discuss how this applies to your specific situation.

Headlines can understandably create uncertainty, particularly when markets appear increasingly dependent on a small number of very large companies. The important thing is to keep short-term market developments in perspective and consider them as part of your wider, long-term financial plan.

If market headlines have left you wondering what they could mean for your investments and your financial plans, your financial planner is there to help you understand the bigger picture.

Important notes: This is a purely educational document to discuss some general investment related issues. It does not in any way constitute investment advice or arranging investments. It is for information purposes only; any information contained within them is the opinion of the authors, which can change without notice. Past financial performance is no guarantee of future results.

Products referred to in this document: Where specific products are referred to in this document, it is solely to provide educational insight into the topic being discussed. Any analysis undertaken does not represent due diligence on or recommendation of any product under any circumstances and should not be construed as such.