Rise in tech stocks drive market concentration concerns

The ten largest stocks in the S&P 500 index constitute over 30% of the market, with tech stocks staging a comeback.

With the ten biggest stocks in the S&P 500 now comprising over 30% of the market, investors are facing a danger in this concentration, urging caution and a more diversified approach to investment.

Martin Hennecke, Asia Head of Advisory at St. James’s Place, shed light on the current state of global stock markets, emphasising the significant concentration risks posed by the predominance of tech stocks. 

"Earnings were quite solid for most companies, particularly the AI leader and media, which recently posted good earnings," Hennecke said, addressing the factors behind the tech stock revival in 2023. 

However, he warned of the "danger of poor concentration risk" and "recency bias risk," highlighting the tendency of investors to flock to markets or sectors that have performed well in recent years, potentially leading to inflated valuations and overlooked opportunities in less popular areas.

Hennecke pointed out that while the U.S. market and tech stocks, in particular, have seen impressive performance, this success could lure investors into a false sense of security, overlooking emerging markets and other sectors that may offer better value and lower valuations.

“We should be careful not to over allocate to the US, particularly those magnificent seven, and don't overlook opportunities and other more depressed markets, for example, emerging markets,” he said.

He added that 2023 saw a unique combination of equities and the fixed interest market dropping sharply, a situation that began to stabilise towards the end of the year due to anticipated interest rate cuts and adjustments by investors to the new market conditions. 

Hennecke highlighted China as an exception, facing challenges due to higher U.S. interest rates which have limited its ability to cut rates aggressively despite experiencing deflation.

“There's no inflation and China actually seems like deflation. So they could have cut more aggressively. But doing so means that there could potentially be outflows and they want to keep the yen stable, as well,” he said.

Looking back at historical performance, Hennecke referenced a chart comparing the S&P 500 to emerging markets from 2000 to 2010, where emerging markets soared over 400% while the S&P remained flat. This example serves as a caution against current tendencies to over-allocate to popular markets like the U.S., while potentially missing out on opportunities in emerging markets or other less favoured areas.

Hennecke also discussed the phenomenon of investors considering reallocating China exposure to India, given the latter's popularity and the premium of the Indian market hitting a record high versus China. He advises caution against over-allocating to any one market based on popularity.