A sharp rise in market concentration

Stockmarket concentration, measured by the share of market capitalization held by the largest companies (Top 10), has doubled in the United States in a decade, rising from 14% in 2013 to 27% in 2023.

Stock Market Concentration. Morgan Stanley

The performance of just seven companies (the "Magnificent Seven") accounted for more than 50% of the 26.3% rise in the S&P 500 in 2023.

This dynamic is not unique to the US: the MSCI All Country World Index followed a similar trend, reaching 20% at the end of March 2024.

A concentration that is far from meaningless

This concentration has some economic basis. In 2023, the 10 largest market capitalizations generated 69% of the market's total economic profit, representing 27% of total capitalization. These companies have very high ROIC (Return On Invested Capital) ratios: 27.4% on average for the top 10 market cap, compared with an average of 10.1% for the Russell 3000. This illustrates a concentration that, in part, reflects real value creation, justified by the competitive advantage of certain companies, particularly in technology.

Economic profit of top 10. Morgan Stanley

The adverse effects of concentration on the real economy

Despite the solid fundamentals of the leaders, excessive stockmarket concentration is harmful to the economy in the long term, according to a study covering 47 countries over three decades (Bae, Bailey, Kang, 2021).

The effects observed include:

  • Less efficient capital allocation: concentrated markets allocate resources less efficiently to growth sectors. This undermines productive investment.
  • Fewer initial public offerings (IPOs): a market dominated by a few large companies hinders access to financing for new companies, limiting their development.
  • Less innovation: concentrated markets slow down patent filings and technological diversity, inhibiting the process of creative destruction.
  • Lower future economic growth: a one-standard deviation increase in concentration predicts a 0.75 percentage point decline in annual per capita GDP growth over five years, representing an impact of more than 33% on average growth of 2.24%.

Impact on active management

Beyond the repercussions on the real economy, which materialize over time, market concentration appears to have an immediate effect on the ability of active managers to outperform the benchmark. At least, in its 2024 report "Stock Market Concentration: How Much Is Too Much?", Morgan Stanley's teams point to a fairly convincing correlation between the share of active funds that manage to beat the markets and the concentration of those markets.

Performance of small versus big and funds outperformance

The underperformance of active funds can be explained by their structural underweighting in large caps. By design, these funds favor less closely followed stocks (i.e., smaller companies), believing that they have an information advantage. However, it is precisely mega-caps that today account for most of the value creation.

At MarketScreener, we have been closely monitoring the acceleration of market concentration for several years, particularly through our study of the SMB premium. This trend is all the more worrying in an environment where investors are buying what is rising (the concept of momentum, in Europe and the US for example, unlike in Japan) and turning en masse to index-based management.

Main sources:

  • Mauboussin, Callahan – Stock Market Concentration: How Much Is Too Much?, Morgan Stanley, 2024

  • Bae, Bailey, Kang – Why is Stock Market Concentration Bad for the Economy?, J. of Financial Economics, 2021