The dominance of megacap tech stocks is not only shaping the U.S. stock market but also exerting a significant influence on the global financial landscape. Presently, U.S. equities constitute 70% of the MSCI World Index, a key benchmark encompassing large- and mid-cap companies across 23 developed markets.
This level of concentration marks the highest since the index’s inception in 1986, underscoring a diminished exposure to non-U.S. stocks. Notably, the top five largest-cap U.S. stocks—Apple, Microsoft, Nvidia, Amazon, and Meta—contribute nearly a fifth of the index’s value.
Over time, the regional and country weights within the MSCI World Index have fluctuated in response to broader economic trends.
While Japanese equities dominated during the 1980s and European markets surged in the early 2000s, the current concentration in the U.S. market stands as unprecedented. This lack of diversification poses risks as it renders the global market highly susceptible to company-specific factors.
Scott Rubner, managing director at Goldman Sachs, emphasizes the substantial impact of this concentration. He notes that allocating $1 passively to the iShares ETF corresponding to the MSCI World index (URTH) directs 70 cents into U.S. equities, with 18 cents allocated to the top five U.S. stocks.
The absence of diversification raises concerns, particularly as historical precedents suggest that such concentration often precedes significant market downturns. Instances in the late 1920s to early 1930s and in 2000 witnessed high levels of market concentration coinciding with market peaks.
Peter Berezin, chief investment strategist at BCA Research, warns of potential risks, suggesting that the market currently treads on precarious ground, with an elevated risk of setbacks.
He advises longer-term investors to interpret the current megacap tech rally as a potential harbinger of an end-of-year downturn.
The pronounced tilt towards U.S. stocks is propelled by the surge in major tech companies, fueled by expectations of artificial intelligence driving profitability.
Last year witnessed substantial gains for companies like Nvidia, Meta Platforms, Alphabet, Microsoft, and Apple. However, the concentration in these stocks is deemed risky, drawing comparisons to historical events like the dot-com bubble in the late 1990s.
Phillip Colmar, managing director, and global strategist at MRB Partners underscores the potential hazards of the premium commanded by these mega-cap tech stocks.
He suggests that as long as momentum favors the ‘Magnificent Seven,’ referring to the seven largest U.S. stocks by market cap, short-term portfolio performance will closely correlate with their performance.
Colmar draws parallels to the dot-com bubble and the risk associated with abstaining from participating in such surges during periods of exuberant market conditions.
While high concentration is generally regarded as unhealthy for markets, Mike Dickson, head of research and product development at Horizon Investments, notes that there is more active risk in not holding these names than in holding them, given their significant presence in the overall market.
While active managers may find it challenging to maintain substantial overweights to these stocks, the trend may endure.
The lack of diversification is also influenced by the repatriation of funds from overseas markets back to the U.S., driven by a confidence crisis in China’s stock market and geopolitical issues in Europe.
Colmar identifies Japan as a potential bright spot in Asia, citing a tactical buying opportunity due to a depreciated Yen, government-supported domestic momentum, and global trade cycle dynamics.
However, opinions on European equities vary among portfolio managers. While earnings across European companies outperform, prevailing pessimism towards the eurozone has led to stocks trading at a discount, presenting an opportunity.
Berezin, however, remains pessimistic about the euro zone’s prospects, recommending investors focus on sectors rather than regions. He highlights that although European stocks are attractively priced, the limited tech presence in the region renders existing tech stocks relatively expensive.
All over the concentration of megacap tech stocks in the U.S. market is raising concerns among investors, drawing parallels to historical events preceding market downturns.
The lack of diversification and the significant influence of these stocks on global markets pose risks, with the ongoing rally possibly signaling an impending market correction by year-end.
Investors are advised to cautiously navigate the market landscape and consider diversification opportunities in other regions, such as Japan while remaining wary of the challenges associated with high market concentration.
