In a recent discussion, Chief Investment Officer Mark DiOrio, CFA discussed the growing market concentration risk, focusing on the “Magnificent Seven” mega-cap tech stocks and their impact on the S&P 500. They highlight that just 10 stocks are currently responsible for around 80% of market movement, pushing the index to its highest concentration levels in 50 years. The conversation explains how the S&P 500's market-cap weighting amplifies this effect, making the index less diversified than it appears. While the Mag Seven have underperformed recently, driving overall index losses, the rest of the S&P 500 has remained relatively flat.
The discussion also points out how these large companies are spread across multiple sectors—tech, consumer discretionary, and communication services—which further amplifies risk. Despite comparisons to the early 2000s tech bubble, the current trend is seen as more gradual due to strong earnings and profitability. The takeaway is a reminder of the importance of diversification and cautious portfolio construction, as the market may slowly shift away from overconcentration in a few dominant firms.
Transcript:
Erin: Mark, very good to see you. I am really excited about today's topic, the Magnificent Seven effect, what market concentration risk means for investors. So today we're gonna dig into one of the most talked about risks in the market. You and I have covered it before concentration risk. Of course, we've discussed how 80% of the market's movements due to only 10 stocks Right now. It's really incredible.
So I wanna talk through specifically the mega cap stocks and techs dominance. So regarding the mega cap stocks here, how concentrated is the s and p 500 right now in terms of its largest stocks?
Mark: Sure. What you're looking at at this chart is the bottom clip represents in orange there, the percent of the S&P 500 that's comprised of the 10 largest stocks. So remember, the S&P 500 is what's called market cap weighted, which means the largest stocks get the largest share of the S&P 500. And the way you get market cap is you multiply the number of shares outstanding of a company times its price. And so that's what market cap is composed of. So whether they issue more shares or they, or stock prices rise, is how the increase in the market share gets. But anyway, this is a chart of the 10 largest, and you can see we've eclipsed, we're at 50 year highs for the level of concentration.
So I think that's very notable on the market and, and it has great implications. Now, there's a lot of news flow when we're in a heavy news flow era. Some, but this is the really inside the market movements is gonna explain a lot more over the next several years for individual portfolio performance and how the market actually acts. So this, this is a, a key key indicator that we're looking at.
Erin: how have the magnificent seven stocks impacted the S&P five hundred's performance this year?
Yeah, so if you narrow down that top 10 to just the, the mag seven or the seven stocks, and you can see those listed on the lower left hand side of this chart, the usual suspects, but year to date, the Mag seven stocks were down 14% and that drove the s and p down a little more than 5% through April. But the other 493 stocks were little changed, actually declined less than 1%.
But really didn't, in fact, the overall market. So despite all the headline risks and so forth, that's not really what drove performance in the, the market really didn't get that upset other than normal volatility and anything kind of causes volatility. But in terms of performance, it was really driven by that underperformance of the Mag seven stocks.
Erin: I'm glad you brought that up, mark. I've been recording with our advisors for, you know, what feels like many months now, but at one point they had lost the mag seven had lost 2 trillion since just the start of the year. This is the three month performance, so it's interesting to talk it through. I'm glad we get the chance. Now let's move on to our next question here. Is it fair to say the tech sector is now overrepresented in the index? And what are the implications because of that?
Mark: Yeah, definitely. So you'd have to go back to, about the year 2000, the bubble era, and this is a great chart here that shows in blue. There is the percent of the S&P 500 in the tech sector specifically. And so we've eclipsed 30%, which was only seen, and this is a 50 year chart at the bubble peak of 2000. And so, we're definitely at extreme levels in terms of that level of concentration.
Now, one of the differences is that in the bubble peak, it, it was very sharp. It was over essentially maybe less than two years, February, let's say of 98, that area to February of 2000. And the bottom clip kind of shows you that extreme relative performance move concentrated in stocks that up drastic up and then down. So I don't think it's a bubble bursting in that sense. This took a number of years to build up. And those, those companies and the, the Mag seven stocks actually highly profitable. That's different than in the year 2000 where they're highly unpro. There's a few profitable, but there was a lot more stocks that kind of participated in this, and tech stocks that participated in, in that rally. This is something definitely of note, that you have that high level of concentration in the tech sector.
Erin: The Mag seven stocks do seem to span multiple sectors. So how does that amplify the concentration risk?
Mark: Sure. So even though the MAG seven are really associated with tech stocks, they actually infiltrate a couple of different sectors or three sectors. So at the tech stocks on the bottom or the tech sector, you have Microsoft, Apple, Nvidia, that represents about 60%, just those three stocks of the entire sector. Then you go to consumer discretionary, the middle clip there, and it's Amazon and Tesla represent 50% of that sector. And then you go up to communication services, top clip, and it's Facebook and Google. That's about two thirds of that entire sector.
So these are pervasive, extremely important, extremely important to understand the sector concentrations that you have there, and then its implications on the, the overall market.
Erin: As we've talked about many times before, even though it's 500 stocks, of course the S&P 500 is not a well diversified portfolio, but how much does owning the s and p 500 today resemble owning just its top stock or top stocks?
Mark: The S&P 500, as I mentioned earlier, and in an earlier slide, showed that the other 493 stocks of the S&P 500 outside of the mag seven actually held up very well, but the overall performance was driven by that Mag seven. But this chart shows in blue, the blue line there is the S&P 500, and the bottom chart there, kind of the multicolored chart shows investing in the largest market cap stock at the time, and then just switching out. And what you see is the S&P 500 actually outperforms that largest mega cap stock.
So it's really just an illustration to understand that, you know, we've been through and, and markets go through different phases and cycles, but we've been through a pretty unique period where the largest stocks have have outperformed that can correct it itself. And it doesn't have to be in a dramatic way, it's just a relative performance metrics. So if you've invested in the largest stock, largest single stock over the last 50 years, you would've made money. However, being in a more broadly diversified portfolio like the S&P 500, or a broad equity portfolio like the S&P 500 actually outperformed because there's a number of other stocks that could start to perform better over time.
So that's just a really reminder that we don't wanna concentrate portfolios and that we don't wanna get overconfident. Even those companies are still gonna be very important. And a lot of those, large cap companies of the past can be continue to be important companies. But that doesn't necessarily translate into stock market performance. So that, and that's what we're concerned about as investors. How do we build an entire portfolio to make sure that we participate in the gains that the overall economy drives.
Erin: I have one more question for you. Do you see this concentration risk changing anytime soon?
Mark: I think it's a, it'll be a slow, it's not like the bubble effect of 2000 because earnings are actually pretty good and are pretty solid and strong. So it'd just be, it would be more of a slow downturn. So in 2000 you saw that quick upturn concentration tech sector, and then just as quick downturn here, this took a number of years to build up into that concentration level. So this will take a number of years as well. So it won't be as, as dramatic of a turn. But we are in that phase where I think it is turning, and that some unloved areas of the market really, it'll start to perform on a relative basis better than they have.
Erin: Interesting. All right, mark, I love it when we can get granular about this stuff. This was really interesting. Thanks for your time today.
Mark: Thanks, Aaron.
