Market Concentration Nears Record High: Should Investors Worry?

Is the Stock Market Getting Too Top-Heavy?

Ever feel like you're watching a basketball game where only a few players are actually scoring? That's kind of how the stock market feels right now. We're seeing a level of concentration where just a handful of stocks are driving the majority of the market's gains, and history suggests this might not be a great sign.

The Top-Heavy Market

When we look at the S&P 500, the market cap of the biggest stocks compared to the smaller ones is at a near record high. It's like a giant pyramid, with a very small base holding up the entire structure. The last time we saw this kind of concentration was right before the Great Depression. Now, I'm not saying we're headed for another depression, but it does make you think twice, doesn’t it?

This concentration is a natural part of market dynamics. Money flows into what's working, driving those stocks higher. But eventually, that trend can only go so far. When there are no more buyers, the whole thing unravels. We saw this before the dot-com bubble burst, during the financial crisis, and even more recently in 2020.

Performance Driven by a Few

It’s not just about market cap, it's also about performance. Since the market bottomed in October 2022, a staggering 60% of the S&P 500's gains have come from just 10 stocks. Let that sink in for a moment. Another 10 stocks accounted for about 11% of the gains, leaving the remaining 480 stocks to scrape together the last 30%. It's a pretty lopsided situation.

This might sound like the Pareto principle—the 80/20 rule—where a small number of things drive the majority of results. And that's true in many areas of life. But the degree of concentration we're seeing now is abnormally extreme and tends to precede market corrections or bear markets.

What Does This Mean For You?

Now, if you're already retired and heavily invested in these few stocks, you might need to rethink your risk management. But for most of us, this could actually be an opportunity. As they say, you make money in bull markets, but you make fortunes in bear markets. When asset prices go on sale, you create a margin of safety that can lead to long-term wealth creation.

Here are some steps you can take:

• Keep dry powder: Have some cash on the sidelines ready to deploy when assets go on sale.
• Consider stop losses: Implement stop losses to protect your positions. Maybe even consider trailing stops for more aggressive protection.
• Be strategic with options: If you're comfortable with options, consider using well-timed puts when the market feels overbought.

Looking Back, and Forward

If we look back at 1999, 2007, and 2021, we see similar patterns of high market concentration followed by a dip. When that concentration falls, the market tends to fall as well. In 2000, we saw a 50% drop, followed by a 57% drop in 2009, and a 27% drop in 2022. Now, I'm not saying we'll see another 50% crash, but a 10-20% correction wouldn’t be unreasonable to prepare for.

The key here is to be proactive. Don't just sit around and let the market dictate your financial future. Take an active role in your financial education and portfolio management. I've seen this play out time and time again, and I encourage you to be prepared, not panicked.

Final Thoughts

Market concentration is a real phenomenon, and right now, it's at a level that should make us sit up and pay attention. But with the right preparation and a bit of strategic thinking, you can navigate these waters and come out ahead. Remember, it's about being prepared, not panicked, and that's something I've learned over my years in this business.