U.S. large-cap markets delivered another impressive year of returns in 2021. And once again the vast bulk of gains were driven by a handful of mega-cap stocks.
The largest of the large caps—companies such as Apple, Amazon and Tesla—continued to wildly outperform the broader Russell 1000 Index, expanding on the mega-cap momentum cycle that has surged since 2018. Indeed, take out its top five mega-cap names and the index’s 2021 total return falls 6.53%, from 26.46% to 19.93%.1
This run-up has resulted in more than just spectacular returns for investors. It also has pushed market capitalizations for these companies to unprecedented levels, dramatic in both magnitude and pace, with no signs of slowing down. Consider, for example, that Apple took nearly 40 years to become the first publicly traded company to reach a market capitalization of US$1 trillion in 2018 and then only three more to almost triple its value to US$2.94 trillion by the end of 2021. Four other companies have also surpassed the US$1 trillion threshold.
This type of remarkable price expansion in just a few stocks has pushed market capital concentrations to historically high—and potentially troubling—levels.
As of December 31, 2021, the 10-largest stocks in the S&P 500 make up 29% of the index, with the two largest, Apple and Microsoft, weighing over 6% each. This has never occurred in 30 years of data! The combined weight of Apple and Microsoft is larger than that of all stocks in the utilities, real estate, materials, and energy sectors.
The figure below shows the market weight of the 10 largest stocks within their respective market indexes. It illustrates that market capital concentration is at extremely high levels in the U.S. and global markets based on their relative index history. Conversely, we observe that non-U.S. developed equity market concentration is on the lower end of the spectrum.
A deeper look shows that capital concentration has been led by the seven largest U.S. growth companies (eight stocks given Alphabet Class A and C); Apple, Microsoft, Amazon.com, Alphabet, Tesla, Meta Platforms, and Nvidia now have a combined weight of 27% in the S&P 500 Index. As little as three years ago, Nvidia wasn’t even the largest or second-largest stock in the semiconductor industry, but is now one of the largest companies overall in the index.
The weight of the consumer discretionary sector within the S&P 500 briefly surpassed the healthcare sector for the first time in almost 20 years, due primarily to Amazon.com and Tesla. The information technology sector is now 29% of the index, more than half of which is just three stocks (Apple, Microsoft, and Nvidia). The three largest communication services stocks, Alphabet Class A and C and Meta Platforms, represent roughly 60% of the sector, whereas the three largest industrials stocks represent just 15% of the industrials sector. The list of these kinds of concentration shifts goes on and on.
The net result is that the S&P 500 and most other popular capitalization-weighted U.S. large-cap indices are now much less diversified than they were just a few years ago, in terms of both individual stock weights and performance drivers. This is evidenced by the large outperformance in capitalization-weighted returns versus equal-weighted returns. Over the past five years, the capitalization-weighted returns for the S&P 500 and Russell 1000 indices have outperformed their equal-weighted returns by more than 25.8% and 41.1%, respectively. Compare this to the 20-year longer-term averages where the equal-weighted indices both consistently and significantly outperformed.2
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The current top-heavy nature of the U.S. large-cap market should give investors pause. Most capitalization-weighted U.S. large-cap indices now appear highly concentrated at both stock and sector levels, which has meaningfully diminished the diversification characteristics of these benchmarks and the passive strategies that seek to mirror them. To find out how this trend has pushed a key economic indicator to concerning levels, download the full paper.
1 This calculation does not reweight the index to 100% without the five top-performing mega-cap stocks. Removing these five stocks and reweighting the index results in a 2021 total return decline of 2.20%, from 26.46% to 24.26%.
2 All weights and figures as of December 31, 2021.
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