by Michael J. Mauboussin and Dan Callahan, CFA, Morgan Stanley
Michael Mauboussin and Dan Callahan discuss rising concentration (risk) in the U.S. equity market. Get the report below:
Key Takeaways
Rising Concentration
- Stock market concentration in the U.S., measured by the market capitalization of the top companies, has risen sharply in the last decade. The top 10 stocks accounted for 27% of total market capitalization at the end of 2023, up from just 14% in 2014.
- This increase in concentration has been driven by the outperformance of large-cap stocks, especially major technology companies like Apple, Microsoft, Alphabet, etc.
Historical Context
- While the current level of concentration is high relative to recent decades, it is not unprecedented historically. Concentration was even higher in the early 1960s and 1930s.
- Just 17 companies have been among the top 3 largest by market cap since 1950, highlighting how few firms reach and sustain that elite status.
Fundamentals Support Concentration
- The rising concentration appears justified by fundamental corporate performance. From 2014-2023, the top 10 companies generated 47% of total economic profit despite being only 19% of market cap on average.
- The return on invested capital (ROIC) for large-cap stocks has significantly exceeded that of small-caps in recent decades, supporting their larger market valuations.
Implications for Active Management
- Rising concentration makes it harder for active managers to outperform cap-weighted indices, as they tend to be underweight the top stocks driving index returns.
- In years when large-caps outperform, fewer active funds beat their benchmarks. From 1960-2023, just 30% of funds outperformed when concentration was rising versus 47% when it was falling.
Outlook
- It's unclear if concentration will continue rising from current levels or mean-revert lower. Assessments of competitive advantage and growth prospects for the largest companies will be key.[1]
In summary, while high by recent standards, the current level of U.S. stock market concentration has precedent and appears grounded in the superior fundamentals of a small cohort of leading companies, posing challenges for active managers benchmarked to cap-weighted indices.
Citations:
[1] article_stockmarketconcentration.pdf
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