By Jamie McGeever
ORLANDO, Florida (Reuters) -Another wave of U.S. tech euphoria lifted Wall Street to new highs on Tuesday, this time in the shape of a deal between Microsoft and OpenAI, a day ahead of a clutch of U.S. Big Tech earnings and the Federal Reserve’s policy decision.
In my column today, I look at the U.S. stock markets’ record concentration and the iron grip ‘Big Tech’ has on Wall Street. By global standards, however, the U.S. isn’t actually that top-heavy at all.
If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.
Today’s Key Market Moves
Today’s Talking Points
* Tech venture mania
Another strand was added to the tangled U.S. tech and artificial intelligence ecosystem on Tuesday as Microsoft and OpenAI reached a deal to allow the ChatGPT maker to restructure itself into a public benefit corporation, valuing OpenAI at $500 billion.
Many Big Tech firms have commitments, joint ventures, or tie-ups worth hundreds of billions of dollars with one another. OpenAI and Nvidia are two of the most involved. Skeptics argue not all will play out as flagged and concentration risk is only increasing, but for now, they are enough to keep the AI-fueled market juggernaut going.
* U.S. job losses mount
Amazon and UPS on Tuesday announced combined job losses of at least 62,000, among the biggest round of publicly confirmed job cuts in a year that has seen a slow, steady drumbeat of firms shedding workers.
How much this gets on Fed officials’ radar remains to be seen. But at the very least, and with no economic data being released due to the government shutdown, it is a sign that the labor market is weakening, perhaps even more than they have bargained for.
* Fed to deliver
The Federal Reserve is widely expected to cut interest rates again on Wednesday by a quarter of a percentage point, and according to rates futures markets, repeat the move in December and at least twice more next year. Let’s see what signals Chair Jerome Powell gives about that.
There may also be some big changes around the Fed’s balance sheet and the plumbing of the U.S. banking system, with the Fed perhaps announcing it will end QT soon. Indeed, this could open up the possibility of the Fed buying bonds or bills in the near future.
US stock market concentration is less extreme than you think
With Wall Street scaling fresh peaks and five of the “Magnificent Seven” U.S. tech giants reporting earnings this week, investors’ focus is once again zeroing in on record-high stock market concentration and the risks associated with it. But this concern may be overblown.
This is not a new debate, but it has raged in the last two years, particularly with the explosion in Nvidia’s share price. The chipmaker’s market cap has quadrupled since 2023 to $4.5 trillion, lifting the Mag 7’s share of the S&P 500 above the 30% mark.
However, surprising as it may be to many market-watchers, concentration on Wall Street is not that extreme by global standards. In fact, the U.S. lags well behind many developed economies when it comes to equity market concentration, and even further behind some key emerging economies.
AMERICAN UNEXCEPTIONALISM
When looking at a dozen of the world’s largest stock markets, the U.S. is actually the fifth-least concentrated, according to Michael J. Mauboussin and Dan Callahan at Morgan Stanley.
The top 10 U.S. stocks accounted for 33.8% of total market cap at the end of September this year. Only India, Japan, China and Canada were less concentrated, while concentration was most extreme in France, Taiwan and Switzerland.
It should be noted, however, that Taiwan is an outlier, heavily skewed by Taiwan Semiconductor Manufacturing Co, the world’s biggest producer of advanced chips. On its own, TSMC accounts for over 40% of the country’s entire stock market cap.
Meanwhile, equity market concentration appears to be intensifying in key emerging economies, primarily driven by tech. That was the conclusion of research published this year by Morningstar’s Lena Tsymbaluk and Michael Born.
They analyzed China, Brazil, South Korea, Taiwan and India, five countries that account for 80% of the Morningstar Emerging Markets Target Market Exposure Index. Morningstar’s Target Market Exposure indices include a country’s or region’s 75% most liquid stocks in terms of trading volume and turnover.
Based on these criteria, the top five stocks at the end of last year represented 27% of India’s market compared with 35% in China, 46% in South Korea, 47% in Brazil, and 72% in Taiwan. For comparison, the equivalent shares in Morningstar’s U.S., UK and global TME indexes were 26%, 17.5%, and 33%, respectively.
For all the fretting that Wall Street’s eggs are all in the one Big Tech basket, concentration risk is more extreme in other countries – something that U.S.-based investors seeking to diversify their portfolios by going into overseas markets should perhaps bear in mind.
DOES IT MATTER?
This all raises the inevitable question of whether market concentration really matters.
To be sure, it is hard to “beat the market” when mega-cap stocks make outsize gains. That is often the case during periods of high concentration, as returns tend to be driven by the handful of stocks at the top rather than all the individual names underneath.
Look no further than the U.S. for evidence of this. Only 8% of surviving active funds in the U.S. large-cap blend category beat the passive alternative over the decade ending June 2024, according to Morningstar. The Mag 7’s footprint in U.S. earnings and performance is simply too large.
There are also concerns that high concentration increases risk, given that one is essentially betting on the performance of a handful of companies.
In the U.S., many worry that the tech bubble – or, more specifically, the artificial intelligence bubble – will burst. With valuations so high, Cassandras fear that this top-heavy market will simply keel over. But obviously none of those outcomes has come to pass.
Of course, there may be a day of reckoning, but it may not be for some time. And it is certainly not inevitable, given the strength of these tech giants’ earnings and how entrenched investors’ “buy the dip” mentality has become.
It is ultimately a classic risk-reward dilemma. If you want a more balanced portfolio, diversify more because a sharp reversal in tech could trigger an outsized downturn. If you want to keep enjoying the returns generated by the biggest names, there is no need to rock the boat.
Currently, the bigger risk may be betting on a reversal too soon. As the market maxim goes, being too early is the same as being wrong.
What could move markets tomorrow?
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
(By Jamie McGeever;)
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