Stock market is more concentrated than ever, raising risks
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The value of the stock market is more heavily concentrated than ever in a handful of companies — making its performance as a whole a function of how just a few megacap tech stocks are faring.
Why it matters: When a few companies dominate the market, that makes passive index investors less diversified, and therefore makes their portfolios riskier.
- As Strategas ETF strategist Todd Sohn told Bloomberg, "The market seems intent on breaking index rules that have existed for decades."
How it works: One generally accepted way of measuring concentration is to look at the Herfindahl-Hirschman Index, or HHI, more familiar from its use in antitrust enforcement.
- HHI takes a sum-of-the-squares approach: It squares the market share of each S&P 500 component, and then adds all those numbers together.
- If every S&P 500 component was exactly 1/500 (0.2%) of the index, then the sum of the squares — the HHI — would come to 20, the lowest possible score.
- Conversely, if five stocks each comprised 10% of the index, accounting for half the total capitalization, while the other 495 were 0.1% each, then the HHI would be 505.
By the numbers: The long-standing high point, set in March 2000 at the height of the Wintel duopoly, was 123.
- That record was shattered in June 2020, as a handful of high-fliers started to dominate the post-pandemic stock market.
- By August 2020 the S&P 500's HHI reached what was then an all-time high of 159. The AI boom drove it even higher, and the election of Donald Trump has boosted it even more.
- As of Monday, the S&P 500's HHI stood at an eye-popping 207.
The bottom line: Concentration, by its nature, is risky. In a normal market, if three or four companies saw their share price cut in half, that wouldn't be devastating for the index as a whole.
- In this market, however, if those three or four companies included the likes of Apple and Microsoft, index investors could see their wealth fall sharply.
