A silver lining in stock market concentration?

The current stock market composition, marked by significant concentration in a handful of tech giants, has understandably raised some eyebrows.

Many investors are concerned that this top-heavy rally could signal underlying fragility.

However, to my mind, a closer examination suggests that this concentration might not be as alarming as it appears and could even be a positive indicator for future market performance.

Firstly, it’s important to recognize the strong fundamentals that underpin the current market environment.

The economy is growing steadily, corporate earnings are climbing, and inflation appears to be on a downward trajectory. These factors create a favourable backdrop for equities, supporting the notion that the rally is built on solid ground rather than speculative fervour.

The impressive performance of tech stocks, while overshadowing other sectors, reflects their dominant role in the modern economy. Companies like Nvidia and other tech giants have shown remarkable resilience and growth, driving the S&P 500 to new heights. This concentration, while unusual, can be seen as a testament to the strength and profitability of these leading firms.

In addition, the fact that the average stock has delivered an annualized real return of eight to nine percent over the past 15 months, despite lagging behind big tech, is encouraging.

This performance exceeds historical averages, suggesting that even the so-called underperformers are doing well in absolute terms. This broad-based strength is a sign of a healthy market foundation.

The disparity between the market-weighted and equal-weighted S&P 500 indices highlights the influence of top performers but also indicates potential for broader market gains.

The Federal Reserve’s high-interest rate policy has kept many stocks in check, while tech giants have surged ahead.

When the Fed eventually lowers rates, it’s reasonable to expect that the rest of the market, which has been more restrained, will catch up.

This anticipated broadening of the rally could lead to a more balanced and sustained market growth.

Concerns about market concentration often stem from fears of volatility and fragility. However, it’s essential to consider that economic and market risks, such as inflation or reduced consumer spending, would impact the market regardless of its concentration. These are inherent challenges that investors must face in any market environment.

In fact, the current concentration might indicate that the broader market is ripe for outperformance.

The high concentration could reflect pent-up potential in the average stock, which has been held back by cautious monetary policy.

As the central bank eases its stance, we can expect a more widespread rally, with gains extending beyond the tech sector to include a diverse array of industries and companies.

Investors should take a broader perspective, in my opinion. Recognizing that the current market environment is conducive to sustained growth, could the perceived fragility of concentration give way to an even more inclusive and resilient rally?

Nigel Green is deVere CEO and Founder

Originally published at Arabian Post.