Market Concentration: Risky Business or Sign of Progress?

Feb 26, 2025 | 5 min read

Top Line Summary

• Market concentration in the S&P 500 has reached its highest level in nearly half a century, raising concerns about diversification and valuation risks.

• Historical data shows that high market concentration often coincides with periods of major innovation, from railroads and industrial titans to today’s tech giants.

• Concentration isn’t inherently good or bad; it signals both potential risks and opportunities, prompting investors to carefully consider portfolio exposure and diversification.

Market Concentration: Risky Business or Sign of Progress?

When it comes to the stock market, few trends have sparked as much conversation recently as the growing concentration in the S&P 500. Today, just ten companies make up over a third of the index—a level of dominance not seen in nearly half a century. It's understandable why this might raise eyebrows. Investors worry that an index so heavily weighted toward a handful of mega-cap tech giants could expose portfolios to heightened risk if those few companies stumble.

Exhibit 1: The 10 largest stocks in the S&P 500 account for more than a third of total market cap

Source: FactSet, Compustat, Goldman Sachs Global Investment Research

But is this necessarily a bad thing? Or is there more nuance to the story?

Recent research, including a Goldman Sachs forecast and a deep-dive from Finaeon examining over two centuries of U.S. market history, offers some thought-provoking insights. As with most things in investing, the reality is less black and white—and more about understanding the trade-offs.

Why High Market Concentration Raises Concerns

From a risk-management perspective, diversification is often hailed as the "only free lunch" in investing. When a handful of companies drive most of the market’s performance, it can create vulnerabilities:

• Diversification Risk: Portfolios tracking the S&P 500 may be less diversified than they appear. If a top company falters, the impact on index returns can be outsized.

• Sustainability of Growth: History shows that even the most dominant firms struggle to sustain high growth and profit margins indefinitely. Overpaying for concentrated exposure may lead to disappointment if growth expectations aren't met.

• Valuation Concerns: The largest stocks often trade at premium valuations, raising the question of whether investors are paying too high a price for perceived stability and growth.

Goldman Sachs' research reflects this caution. Their baseline forecast for the S&P 500's annualized return over the next decade is just 3% (compared to the historical average of around 11%). Interestingly, if market concentration were removed from their model, that forecast would rise to 7%.

Exhibit 2: S&P 500 annualized trailing 10-year returns: modelled vs. realized (1930-2024) and forecast (2024-34E)

Source: Robert Shiller, Goldman Sachs Global Investment Research

But History Suggests There’s More to the Story

While it’s easy to view high concentration through a lens of risk, the Finaeon study—which analyzes 235 years of U.S. market data—paints a more nuanced picture. Throughout American history, market concentration has ebbed and flowed, often reflecting periods of profound innovation:

• Early 1800s: Banks dominated the market as financial institutions formed the backbone of economic growth.

• Late 1800s: Railroads surged, reshaping transportation and commerce.

• Early 1900s: Industrial titans like Standard Oil and U.S. Steel took center stage during the American commercial revolution.

• Mid-20th Century: The first "Magnificent Seven"—a group of dominant industrial and technology companies including AT&T, General Motors, IBM, Standard Oil, General Electric, DuPont, and U.S. Steel—held sway over the market. These companies were industry leaders of their time, driving innovation and setting global standards in telecommunications, manufacturing, energy, and materials. Their prominence reflected America’s post-war economic boom and industrial strength.

• Today: Technology and AI-driven companies command significant market share, reflecting their role in shaping modern life.

Exhibit 3: United States Sectors as a share of the Total, 1793 to 2023

Source: Bryan Taylor, Chief Economist, Finaeon

What stands out is that market concentration often rises during bull markets fueled by breakthrough innovations. These dominant companies frequently drive productivity gains, improve global connectivity, and pioneer technologies that enhance our everyday lives. Larger firms also have the resources to invest heavily in research, scale operations globally, and navigate economic headwinds—benefits that smaller competitors may struggle to match.

Exhibit 4: Top 10 Stocks as a Percentage of the Top 500 Stocks, 1875 to 2024

Source: Bryan Taylor, Chief Economist, Finaeon

Does this mean investors should embrace concentration without question? Not necessarily. But it does suggest that concentration can be a byproduct of progress rather than an automatic red flag.

Striking the Right Balance

So where does this leave investors? On one hand, relying heavily on a handful of mega-cap stocks poses risks, especially if valuations become stretched or growth stalls. On the other, history shows that market leaders often dominate for good reason—innovation, efficiency, and global reach.

Rather than seeing market concentration as inherently good or bad, it may be more helpful to view it as a signal. It prompts important questions:

• Are the dominant companies still innovating and expanding their competitive advantages?

• Do their valuations reflect sustainable growth, or is optimism running ahead of fundamentals?

• How exposed is my portfolio to a handful of stocks, and am I comfortable with that risk?

• Are there diversification strategies (such as equal-weight indices or sector diversification) that can help mitigate concentration risk without missing out on market leaders?

The Bottom Line

Market concentration is neither a new phenomenon nor a simple one. Sometimes, it signals an overreliance on a few market darlings. Other times, it reflects genuine innovation and progress that benefit both investors and society. The challenge lies in discerning which is which.

As always, thoughtful portfolio construction, regular re-evaluation, and an awareness of market dynamics are key. Concentration may offer rewards, but it also warrants caution.

At Israilov Financial, we help clients navigate the complexities of market trends like concentration and innovation-driven growth. Our team provides personalized investment strategies that balance opportunity with risk, ensuring your portfolio is aligned with your goals and market realities. Schedule your free discovery meeting today and let’s explore how to position your investments in an evolving market landscape.

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REFERENCES:

1. 200 Years of Market Concentration - Finaeon, accessed February 24, 2025 https://www.finaeon.com/200-years-of-market-concentration/

2. Global Strategy Paper: Updating our long-term return forecast for US equities to incorporate the current high level of market concentration - Goldman Sachs, accessed February 22, 2025 https://www.gspublishing.com/content/research/en/reports/2024/10/18/29e68989-0d2c-4960-bd4b-010a101f711e.html

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IMPORTANT DISCLAIMERS

Past performance is no guarantee of future returns

The graphs and charts in this commentary are for illustrative purposes only and not indicative of any actual investment. Index returns do not reflect any fees, expenses, or sales charges. It is not possible to invest directly in an index. Stocks are not guaranteed and have been more volatile than other asset classes. Historical returns were the result of certain market factors and events which may not be repeated in the future. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgement in determining whether investments are appropriate for clients.

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities.

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