How has index concentration shifted historically and why might a diversified, cap-weighted benchmark like the S&P 500 already be tracking tomorrow’s market giants? S&P DJI’s Ben Vörös sits down with Tim Edwards to discuss Tim’s latest research, In the Shadows of Giants, and examine whether the dominance of a few large companies may be a signal of risk or opportunity for market participants.
[TRANSCRIPT]
Ben Vörös:
Hello, I'm Ben Vörös, and in this special edition of The Market Measure, we have Tim Edwards, the Global Head of Index Investment Strategy here at S&P Dow Jones Indices, with us to talk about his new research, In the Shadows of Giants.
Welcome, Tim.
Tim Edwards:
Thanks, Ben.
Ben Vörös:
So, there's a lot of talk about the markets, and talk on the markets about index concentration. And, as we have observed over the recent couple of years, the S&P 500 has become more and more concentrated, and currently, the top 10 companies make up about 40% of the index. So, do you think it's a systemic risk, and should investors be worried about the implications?
Tim Edwards:
One of the most important trends within the U.S. equity market and in the benchmarks that measure that market over the past decade or so has been a really strong performance from the very largest stocks and, in particular, some very large tech or tech-related stocks. This is not a new phenomenon. In fact, the acronym FAANGs was coined more than a decade ago, and we've had different groupings. The Magnificent 7 is one that people have heard a lot about more recently. The constituents have changed somewhat, but not much, and what you've had is over the last 10 years or so, the very largest stocks increasing faster in price, market caps increasing, and they've come, "Top 10" is the measure we used in our research, to represent around 40% of the S&P 500. Now, we don't know, of course, what will happen in the future, but with the benefit of coming up for 70 years of history of the S&P 500, we can look back at history and say, what happened last time? This isn't the first time that just 10 stocks have been about 40% of the index. The last time it happened, though, was all the way back in 1965. So, we looked at the relationship over time between concentration and performance.
Let's start with what happened last time. And, in some sense, the picture might be quite worrying, but there's an important qualifier to that. So, the Top 10, 60-ish years ago, were very different. So, names like AT&T, Sears, Kodak, General Motors, and a few others. But, I highlight those ones in particular because they're quite famously companies that were once considered icons of U.S. corporate quality. And, three of them went bankrupt and the other one had a very torrid time. Those companies and their successors and things they spun off into went from being a 40% weight in 1965, or thereabouts, down to almost a tenth of that by the midpoint of 2025. So, it's certainly true that large companies may get smaller again.
What's fascinating is, when, if you look at the interaction between their performance and the overall market, because even though you had 10 companies that represented 40% of the index, and those 10 companies had a really terrible next 50 years. All of them underperformed. Nonetheless, we had fantastic, I say fantastic, really strong 10% per annum growth in the S&P 500 overall. So, the first message is that high concentration is not necessarily predictive of poor future performance.
Ben Vörös:
The market concentration hasn't been static over time. It's been ebbing and flowing over the nearly seven decades of history for the S&P 500. What has been the historical relationship between concentration and index performance?
Tim Edwards:
Well, there's a sort of obvious thing that happens and a more subtle thing that happens. So, the obvious thing that happens is, and, at least, initially, in that period after 1965, and on a few short-term occasions most recently, if the very biggest stocks do badly, it's often the case that the rest of the market does badly. However, and this is kind of where it gets interesting, that is not always the case. Concentration and performance are not quite statistically independent, but they are close to independent, and if you look decade to decade to decade, sometimes concentration up, sometimes market up, and they're not really following a strict pattern. And, why that happens and how that happens is where it gets really interesting, because there are two ways that concentration can change. And, effectively, you could think of it as it could be that the big guys are doing really badly, or it could be that the other 490 companies are starting to take a turn in the lead.
And, what's important about that is that we have to remind ourselves sometimes that the downside to a stock price is you can lose up to 100%. The upside is almost unlimited. And, when you have these companies that go from relatively small, I mean, still S&P 500 constituents, relatively small to very large, then, in that period, they often can really drive up the overall index returns. Just to give you an example, of the current top 10 constituents, the average member joined 24 years ago at a weight of around a half a percent. They're now at a weight which is around 5%. So, that tells you that their returns approximately have been 10 times what the index was. The actual figures are a little bit close to 7x and not exactly 0.5x. But, the point remains that sometimes concentration can decrease and increase, but what's really happening there is a changing in the guard rather than the same companies taking lower and higher weights.
Ben Vörös:
With market concentration so high, do you think it's time to look away from market-cap-weighted indices toward other solutions?
Tim Edwards:
It's a good question. Of course, cap-weighted indices are still going to be benchmarks because they represent the whole market. But, in an environment where a few stocks come to take up a larger proportion, investors and market participants might be asking themselves, is it wise to have that much allocated to a select few companies?
Here's, if you like, the magic of cap weighting, or here's what might qualify that concern. The first is if, and I say if, the current crop of largest companies falters or just doesn't do as relatively well as it has, their weights in the benchmark will proportionally decrease. More importantly, in a broad diversified benchmark, you may already have in your benchmark the next generation, whoever they may be. And, if those companies do grow and perform very well, then, a capitalization-weighted benchmark will retain participation that scales along with their performance over time. And, I think it's that subtlety which is perhaps underappreciated.
There are plenty of options that investors have to force greater diversification, things like equal weight indices and more. But, in terms of the overall market and a market benchmark, it's important to remember, look, if you cast your mind back 100 years and looked at the stocks that were listed in the U.S. 100 years ago, very, very few of them are even alive today, and, yet, we've had a century of strong performance from capitalization-weighted indices. Why? Because, part of their health, they allow companies to fail in order for others to rise. So, that's kind of what motivated the whole research, and, then, this notion that the next generation may be already in there, is why we called it, In the Shadows of Giants.
Ben Vörös:
Thank you, Tim. And, if you would like to read the whole piece, search for, In the Shadows of Giants, on our website.
I'm Ben Vörös, and this was The Market Measure.
