White Paper

Weighing the Risks of a Top-heavy Market?

Richard Yasenchak, CFA Senior Managing Director, Head of Client Portfolio Management

Key Ideas

  • U.S. large-cap market gains continue to be largely driven by a handful of mega-cap stocks.
  • The incredible run-up in these companies has significantly distorted the diversification characteristics and recent returns of most popular capitalization-weighted U.S. large-cap indices.
  • The U.S. stock market capital distribution curve—which has historically tended to remain remarkably consistent over time—has recently seen a sharp uptick in the eight largest stock weights, unlike anything observed in the past 40 years.
  • Capitalization-to-GDP ratios for the largest mega-cap stocks have climbed to historically high levels, indicating valuations now appear to be overvalued relative to their histories, similar to the increases seen in the dot-com bubble.
  • Consequently, investors may want to review their mega-cap exposures in U.S. large-cap allocations, especially in passive strategies where concentrations have likely spiked higher.
  • Markets have tended to revert to the mean in the long term, indicating it may be prudent to reallocate a portion of large-cap allocations to actively managed, risk-controlled strategies emphasizing broad diversification to help cover investors’ bases should current mega-cap momentum begin to shift.

Mega-cap momentum and capital concentration

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.