It’s the ‘elephant in the room’ of bags. It is a taboo subject for the world of investment, which ignores it with some imprudence and discomfort, but everyone is aware of its presence and the enormous risks it represents for Wall Street and, finally, for the rest of the world’s stock markets. It is so big that it looks like a bubble, and it probably is, but we look at its dimensions to better understand it because it is breaking all records of concentration or stock market dominance
Just seven companies now account for 25% of the stock weighting in the US S&P 500 and 50% of the Nasdaq 100. It means they are responsible for movements up or down in both indices by that percentage. For example, if the seven companies rise 1% and the other 93 companies each fall 1%, the technological selective would end in a draw or tie at the end of the session. Their joint market capitalization exceeds 11 trillion dollars, something like 100 times the size of Inditex or close to 20 times the sum of the components of the Ibex 35.
The ‘magnificent seven’ of Wall Street are none other than Microsoft, Apple, Tesla, Amazon, Meta, Alphabet and Nvidia, which form with their initials an acronym also of western inspiration: MATAMAN. Five of them are above a trillion market valuation, two that are worth more than 2 trillion and one about to reach 3 trillion again. Behind these dizzying figures hides 90% of the rise since January in the S&P 500 (+15%) or the Nasdaq 100 (+31%). History tells us that these behaviors tend to become a time bomb when the market goes wrong. If it is not deactivated -if the rest of the market equalizes and balances the forces- it will end in an explosion, that is, in a stock market crash.
In other words, if the indices present such attractive returns at this time of the year, it is not because companies in general are doing well, but only a small elite of them that in no way reflects the economic direction. As I will tell you, your common financial sense at this point is totally insane because that level of concentration is unhealthy and unsustainable. It is common in shorter indices such as the Ibex 35, the Cac 40 or even the EuroStoxx 50 for a handful of values to have a majority weighting, but what does not seem so common is that they provide for the same in indicators of 100 or 500 shares is like the case of the Nasdaq or S&P.
An analysis by the manager Schroders pointed out in 2020 the high level of concentration taking as a reference only 5 companies, the FAMAG (acronyms for Facebook-Meta, Apple, Microsoft, Amazon and Google-Alphabet). The picture then seemed even worse due to the high degree of dominance of technology companies over other sectors, with banks and energy companies in the doldrums. The study revealed that only 5 companies had not had as much prominence and stock market importance in the US since the 1960s, but advertising for the first time all belonged to the same sector. Another recent Morningstar report highlights that this hyperfocus breaks all records by 2023.
Other similar acronyms with the usual suspects such as the FAANG (with Netflix), the GAFA or the Chinese BAT (Baidu, Alibaba, Tencent) have realized the relevance of technology for investors for more than a decade. However, almost always, the focus was on the positive of the investment trend and on how well these companies were doing. However, the risk that investors’ money is concentrated in a handful of securities can become a problem. In fact, it is if we look at the valuations that many of them present despite the fact that they earn loads of money and are incredibly profitable. Everything has a limit.
Is it financially sustainable?
There are three great invisible forces that feed back this trend over and over again. The first one seems quite obvious and truism: investors in general buy these shares more than the rest. The second is directly related but is harder to see. The high weight in the indices of these companies makes them the main destination for ‘dumb’ or passive money from indexed management. There is nothing wrong with it a priori since these types of strategies have proven to be winners over time due to the lower management costs and the diversification that is assumed. However, the current hyper-concentration goes against that spirit of diversification and causes the performance of an index fund to be tied to the fate of one or two companies.
Third, the Magnificent Seven are huge buybacks of their own shares with hundreds of billions of dollars in recent years, mostly by Apple, Microsoft, Meta, or Alphabet. For some large investors, these equity accumulation plans are a call to ride the wave. They just have to enter the front, catch it on time and let themselves go, as is the case with Warren Buffett, Apple’s reference partner and one of the great defenders of this practice.
Now, can he keep up with the rebuys forever? It would be crazy to say otherwise, but the manufacturer of the iPhone is playing with fire in doing so because it has been experiencing a drop in revenue for more than half a year, its cash flow is shrinking, and the resource of borrowing issuing bonds at ultra-low rates to pay dividends. or the buybacks themselves, as it has done several times in recent years, doesn’t seem too smart. Neither is it if you miss investment opportunities in your own business along the way or if these investments go wrong. Another notable case is that of Nvidia, whose size of one trillion dollars seems to be based on the fact that its chips will dominate the boom in artificial intelligence. And if the competition is also worth that on the stock market? In short, the traditional return-risk formula appears somewhat unbalanced on the Nasdaq in 2023.