Understanding high stock market concentration

What is high stock market concentration?

High stock market concentration is the extent to which a small number of stocks or sectors dominate overall market performance or value. When the stock market is highly concentrated, there’s potential of increasing market risk and decreasing diversification – both of which often impact market dynamics, influencing the decisions and strategies of traders and investors.

What causes high stock market concentration?

1. Dominance by large companies: a few companies may represent a big chunk of the market due to their size, resources and economic power

2. Mergers and acquisitions: as companies merge or acquire others, the number of stocks in the market decreases, resulting in an accumulation of influence and market share in fewer hands

3. Innovation and technological advancements: a company that innovates may gain a competitive advantage that enables growth, becoming one of the market-dominating companies or contributing even more to market concentration

4. Regulatory environment: some regulations may affect smaller companies disproportionately, making it more difficult for them to compete

5. Economies of scale: companies that operate on a larger scale may benefit from advantages such as spreading costs across more goods or services and increasing production through certain efficiencies

What are the implications of high stock market concentration?

When the stock market is highly concentrated, it means that a large proportion of the market's value is accounted for by a relatively small number of stocks. This scenario can have several implications, including:

1. Increased market volatility: a market dominated by a few large companies may experience heightened volatility. Big trades and investments in any of these stocks could disproportionately affect the overall market

2. Vulnerability to company-specific news: market movements can be sensitive to developments within these few dominant companies

3. Reduced portfolio diversification benefits: high concentration can limit the potential benefits of diversification. Plus, adverse events affecting the relevant stocks could impact investment portfolios negatively

4. Increased systemic risk: when the financial system is overly dependent on the performance of a few companies, issues that one of them faces could potentially trigger wider economic challenges

5. Barriers to entry for smaller companies: a highly concentrated market might not be conducive to growth for smaller companies, as they may struggle to compete for market share and investor attention

6. Market manipulation risk: as influencing a few large stocks that drive the market might be easier than having an effect on a broad array of stocks, there could be an increased risk of market manipulation in a highly concentrated market

7. Impact on trading and investment decisions: market participants might focus more on the performance of major firms in their strategies, potentially overlooking opportunities in less prominent stocks

Our analyst’s view on high stock market concentration

Should you be concerned about high stock market concentration where only a few stocks significantly impact an index?

Axel Rudolph, one of our senior analysts, says: ‘Historically, markets dominated by several large companies have generally shown solid long-term results. A high proportion of mega-cap stocks wit¬hin an index often reflects investor confidence in these companies’ growth prospects, which can elevate overall index performance’.

Here’s how a few of the largest companies in the US fared in maintaining a big part of the market share for the past few decades:

Remember, past performance isn’t a guarantee of future performance.

Examples of high stock market concentration

In bull markets, this high stock market concentration tends to be more noticeable as traders and investors focus on industry leaders. For example, in the late 1990s’ technology-led bull market, tech majors like Microsoft and Cisco made up over 25% of the S&P 500's total value, pushing the index up by over 230% from 1995 to 2000.

A similar concentration can occur during bear markets, as industry leaders can also be susceptible to significant declines if sentiment shifts against them, which can – in turn – lead to considerable changes in trading volumes. For example, the NASDAQ 100 plummeted by nearly 90% over about two years after the dot-com bubble.

During bear markets, traders and investors may seek out assets that tend to outperform others in a downturn (eg government bonds and defensive stocks), leading to a higher concentration of those specific assets. This was illustrated during the 2008 financial crisis, where – despite an overall dip in the market – a higher concentration in defensive sectors such as healthcare and consumer staples helped stabilise investor losses.

Stocks with the largest market capitalisations

The stocks with the largest market capitalisations tend to be well-established, internationally recognised companies that dominate in their respective industries and exert significant influence on global economic trends and technological advancements. These companies are valued highly on stock markets around the world, reflecting their substantial assets, revenues and profitability. Some of the main ones are:

1. Apple (AAPL): as a leading technology company, Apple is known for its innovative products such as the iPhone, iPad and Mac computers. Its ecosystem also includes services such as Apple Music and iCloud, all of which contribute to its massive market cap

2. Microsoft (MSFT): known for the Windows operating system and Office productivity suite, Microsoft is pivotal in the software industry. Its growth has also been bolstered by cloud computing services like Azure and a range of dynamic acquisitions

3. Amazon (AMZN): starting as an online bookstore, Amazon has expanded into an international e-commerce giant. Other services which contribute to it being a heavyweight in market cap include cloud services through Amazon Web Services (AWS)

4. Alphabet (GOOGL): as the parent company of Google, Alphabet leads the way in internet-related services and products. Google's dominance in online advertising and ventures into cloud computing and consumer hardware play a key role in its market valuation

5. Tesla (TSLA): known for its electric vehicles, Tesla also has operations in clean energy solutions like solar panels and innovative battery technology. Its ambitious projects and disruptive approach contribute to its sizeable market cap

High stock market concentration summed up

• High stock market concentration is when a relatively small number of companies make up a significant portion of the market, accounting for a major percentage of its overall performance and value

• It may increase market risk and reduce diversification. This could lead to greater volatility, which may present more opportunities for profit, but also a higher risk of incurring losses

• Causes of this phenomenon include dominance by large companies, mergers and acquisitions, innovation and technological advancements, and economies of scale

• It has several implications, eg difficulty for smaller companies to compete, which can have certain negative effects on consumers and the economy (due to systemic and other risks)

• Some of the companies that are dominating the market are Apple, Microsoft, Amazon, Alphabet and Tesla