Why the S&P 500 does and does not have a problem

USD 44,000 billion, or with all the zeroes USD 44,000,000,000,000. That is the market capitalisation of the 500 largest listed companies in the US (as of April 2024). Together, they make up the S&P 500, an index that is considered the most representative indicator of the US equity market. To some people, it even serves as an indicator of the global equity market.

The 500 companies in the S&P 500 constitute approximately 40% of the global equity market (in terms of market capitalisation). In other words, if you added up the total value of the approx. 55,000 listed companies in the world, these 500 account for almost half of that total market value. The S&P 500 is therefore by far the most widely tracked share index in the world.

Companies in the S&P 500 are spread across a wide range of sectors, from technology to healthcare, and from financial services to consumer goods. It is this diversity that also makes the S&P 500 popular with many investors. However, there has been a lot of talk about this diversity recently.

What is the problem with the S&P 500?

The S&P 500 has plenty of large companies, but only a handful are really huge. For example, Microsoft has a market capitalisation of USD 3,000 billion (as of April 2024). To give you an idea, this is roughly the same as the GDP of France in 2023 (= the market value of all services and goods produced in France in 2023).

As the S&P 500 is a market-weighted index – meaning that the largest market capitalisation companies have a greater weighting in the index – these larger companies have a strong influence on the performance of the S&P 500. Simply put, if the share price of the big boys is doing well, the entire index does well. This is good news for investors following the S&P 500, as long as this club of top stocks continues to perform well. But if the tide turns, this will of course put pressure on the entire index.

The problem is: in both 2023 and this year, it is mainly the select group of exceptionally large companies that is dictating the direction of the S&P 500. This group are also known as the Magnificent Seven: Alphabet, Apple, Amazon, Meta, Microsoft, Nvidia and Tesla. Together with three more companies, they make up a whole third of the market capitalisation of the S&P 500. To put it another way: 10 companies have a weighting of 33% in the S&P 500, with the other 490 representing the rest (as of April 2024). It is precisely this high concentration that makes some investors nervous.

The highest concentration in decades

Today, the concentration of the top 10 is the highest in decades. By way of comparison, 33% is well above the 27% at the peak of the 2000 dotcom bubble. In February 2024 the Magnificent Seven were even as large as the combined stock markets of Japan, the United Kingdom and France. According to the bank JP Morgan, the recent increase in concentration is the most rapid in 60 years.

At first glance, investors’ concerns seems justified. The heavy weighting of technology stocks can make investors vulnerable to shocks in this sector. Another concern is the potential distortion of market dynamics. When a small group of companies has a major influence on an index, their share prices may be influenced more by investor sentiment than by the underlying company performance. This can lead to volatility and overvaluation.

Does every disadvantage have a flip side?

The strong concentration of tech stocks has contributed to a period of exceptionally strong returns. The S&P 500 has generated a total return of 16% year-on-year over the past five years, compared to a 30-year annual average of 10%. The top 10 shares accounted for more than one third of that profit. However, stocks are currently trading at lower valuations than the largest stocks did at the peak of the dotcom bubble, according to research by Goldman Sachs.

In addition, a high level of concentration is not unusual. In the mid-1960s, the concentration of the top 10 comprised over 40% of the S&P 500. Given the dominance of a handful of equities, the concentration of the top 10 remained at over 30% for several years. What is more, this is not exclusively an American problem. The MSCI China includes over 700 shares. However, the top 10 account for more than 40% of the index. The same applies to Germany: the MSCI Germany has 57% (!) of its weighting in 10 shares, with 23% in just two shares, SAP and Siemens. In the MSCI UK, too, the top 10 represent more than 50% of the index, with almost a quarter in three stocks: Shell, AstraZeneca and HSBC.

Strong underlying figures

In addition, several of the top US stocks are global market leaders or at least leaders in their sector. If a group becomes a market leader, this often means their shares outperform the rest. This is exactly what has happened. The reason the Magnificent Seven have performed so well in recent times (barring a misstep here and there) is because they are also supported by solid company balance sheets, strong earnings and the potential for robust future growth through AI-driven innovation. The current market concentration is therefore not driven to any great extent by speculation as was the case during the dotcom bubble. The argument that concentration entails risks also needs to be put into perspective. The composition of the S&P 500 changes regularly, indicating a dynamic index where new companies can join in and grow. Companies that are declining in value are replaced by other companies that are gaining in strength. In this sense, the S&P 500 remains an index that investors simply cannot ignore.

How can investors position themselves?

Given the current concentration, it may be worthwhile to review your portfolio and diversify it if necessary. That is, unless you can and want to accept a higher risk. In addition to indirect investments in the S&P 500, it is important to also keep an eye on other indices and markets, such as those in emerging markets or sectors that are currently underrepresented in the S&P 500.

For more risk-averse investors, it may make sense to look at trackers that are more broadly diversified or that focus on specific sectors other than technology. Another strategy could be to invest in thematic trackers that relate to long-term trends such as smart mobility, ageing or water.

The S&P 500 remains an important barometer for the US and also for global equity markets. While the current concentration and the dominance of a handful of large technology companies may be a cause for concern for some investors, it also offers opportunities. It is up to the individual investor to decide how they use this information to shape their investment strategies and manage risks.

Investing in the S&P 500?

Direct investment in the S&P 500 is not possible because it is an index. However, you can invest indirectly via a tracker that models the composition and performance of the index.