1932 was the same! High concentration in the US stock market is not scary; the real danger is that it's too expensive.

On Wednesday, The Financial Times columnist Robert Armstrong published an in-depth article about the concentration in the U.S. stock market. The article discusses the current phenomenon of the U.S. stock market being highly concentrated in a few tech giants, and whether this concentration truly signifies increased market risk.

Armstrong begins by describing a dramatic market day: after AI company Anthropic launched a new legal automation tool, software and professional services stocks fell more than 3%. However, even the tech giants were not spared; instead, traditional sectors such as energy, telecommunications, consumer staples, and materials became the winners. This example illustrates that the market landscape is changing.

Armstrong’s core point is: Market concentration itself is not necessarily scary; what we should really watch out for is high valuations. Although the Mag7 tech stocks no longer dominate the market as they did a few months ago, the S&P 500’s concentration remains high. More importantly, historical data shows that such concentration is not an anomaly; similar situations occurred in 1932.

Market Concentration: Six Companies Support One-Third

How concentrated is the current U.S. stock market? Armstrong provides detailed data. Just six companies account for one-third of the total market capitalization of the S&P 500, with Nvidia alone making up 7%. If you look at the top 62 largest companies, they collectively make up two-thirds of the entire index’s market value.

From a net profit perspective, the situation is slightly different but fundamentally similar. These six giants contribute 27% of net profits, while the top 62 companies contribute 63%. Armstrong points out that this means the largest companies tend to have “higher valuations—price-to-earnings ratios”—compared to smaller companies.

This level of concentration raises a question many analysts are asking: does the high market cap concentration make the market more dangerous? Should investors reduce their allocations to the largest companies or sectors relative to their market weight?

History Tells Us: Concentration Is Normal

Armstrong notes that research by scholars Per Bye, Jens Soerlie Kvaerner, and Bas Werker provides compelling historical evidence. They analyzed data from all companies traded on major U.S. exchanges since 1926, including market caps and various profitability metrics.

The findings are quite surprising. The authors write:

The relative importance of the Mag7 is not particularly unusual. For example, from the 1930s to the 1960s, seven companies held similar shares. “The peak occurred in May 1932, when AT&T, Standard Oil, New York Consolidated Gas, General Motors, DuPont, Reynolds Tobacco, and United Gas Improvement combined accounted for about one-third of the total market value.”

This indicates that market concentration is not unique to the modern era nor a product of the tech age. Similar concentration patterns existed during the industrial era. In other words, a few large companies dominating the market seems to be a normal feature of capital markets.

The research also reveals an important finding: company fundamentals (such as revenue and profit) do track changes in market concentration, but the correlation is loose and exhibits cyclical fluctuations.

The paper further notes that when market concentration reaches extreme levels (i.e., the number of companies accounting for one-third of total market cap drops to a historic low, currently below 0.5%), these largest companies’ shares of total revenue, profit, and cash flow are actually at their lowest levels in history, about one-fifth.

So, does high concentration also imply low long-term returns? The paper states:

Alone, market concentration does have a negative predictive effect on returns (high concentration, low subsequent returns), but controlling for valuation factors changes this… When valuations are held constant, higher concentration is actually associated with higher future returns!

Mathematical Models Confirm: Concentration Is a Natural Outcome

The second part of the paper uses mathematical models to further reinforce the idea that market concentration is a normal phenomenon. The study employs a “standard geometric Brownian motion diffusion process” model, incorporating “common market factors and firm-specific shocks.”

Specifically, in this model, returns follow a stochastic process. Company market values can be imagined as constantly affected by various shocks—productivity and innovation impacts, good or bad leadership, luck, and misfortune. Over time, most companies remain small (their positive and negative shocks offset each other), while a few receive large positive shocks and grow into giants.

To use an analogy, the stock market is like a continuous dice game. Most players’ results tend toward the average, but a few lucky players roll particularly good numbers repeatedly. This is not surprising; it is a natural outcome of probability. Similarly, market concentration is a result of the market mechanism working naturally.

Risk Warning and Disclaimer

        The market carries risks; investments should be made cautiously. This article does not constitute personal investment advice and does not consider individual users’ specific investment goals, financial situations, or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article are suitable for their particular circumstances. Invest at your own risk.