Quick Bite – The US Market’s Concentration Problem
It will be no surprise to regular QB readers that the US share market is very concentrated – we all know about the Magnificent 7. But every now and then, it is worthwhile updating the story and reacquainting ourselves with the opportunities and risks involved.
For example, as reported by John Authers of Bloomberg, the performance of the equal-weight version of the S&P 500 — which effectively measures the average stock by weighting each constituent as 0.2% of the index regardless of their size — compared to the cap-weighted index has dropped to its weakest in 22 years:
Source: Bloomberg
The dominance of the very biggest stocks is quite exceptional, and is different from the dot-com era. This is how the biggest 10 stocks’ weighting in the S&P 500 has changed at five-yearly intervals going back to 2000. It is unprecedented for 2% of the index’s companies to account for virtually 40% of its value:
Source: Bloomberg
This creates a problem for passive or index investors, as buying the index no longer diversifies risk. And yet the leading mega-cap tech stocks have delivered on their growth promises, leaving the rest of corporate USA behind.
Source: Bloomberg
This is not like the dot-com bubble, when hot companies which were all blue-sky and no real earnings, dominated the boards and IPOs. This time, a small group of globally ultra-dominant companies is stripping profits from everyone else. Rather than the market, the concern lies with the companies themselves. How can they make such big profits, and can they possibly retain them?
Source: EdgeandOdds
Recently, something has changed. The big tech groups have been spending vast sums of money far faster than ever before on AI. This is a new development. Tech is usually “capital-light.” Capital expenditures on the computing capacity needed for AI and the energy to back it have surged:
Source: EdgeandOdds
Well-deployed capital expenditures pay for themselves with higher profits, but those profits may (or may not) be in the future. Meanwhile, Big Tech’s free cash flow yield (operating cash flows minus capital expenditures as a proportion of market cap) leaves these companies exposed to the success or otherwise of their AI strategies. Not all of them will be winners in this race.
History suggests that not all the Mag 7 will be quite so dominant and successful a decade from now. It also shows that their current dominance is unprecedented. AI, and their embrace of it, is an extraordinary phenomenon of our times. All should be aware just how much the current positive perceptions of the market and of the US economy rely on it.