Should Investors Be Worried About Concentration in the Stock Market?

When I meet people and they find out that I am a regular contributor here, the first question is usually something along the lines of “Where are stocks going? Up or down?”

I typically reply with “Both.” While not particularly informative, it is at least honest. Recently, though, people have been asking a much more specific question: “Should I be worried that just a handful of stocks are driving the market to record highs?”

It is an understandable concern. According to research done by Michael Maboussin and Dan Callahan at Counterpoint Global, the group that has been labeled the “Magnificent Seven” — Apple (AAPL), Microsoft (MSFT), Nvidia (NVDA), Alphabet (GOOGL), Meta Platforms (META), Amazon (AMZN) and Tesla (TSLA) — have accounted for around three quarters of this year’s gains in the S&P 500, and represented more than half of the gains in 2023. And if you take out TSLA, which is not currently being driven higher by the AI boom and faces its own challenges, those numbers would be even more lopsided.

That feels like a dangerous level of concentration, and the basic principle of reversion to the mean suggests that they will correct before too long. There is, however, another way in which the divergence in performance between big tech stocks and the rest of the market can be reduced: It could be that rather than a collapse in the market leaders, instead, it’s possible that the rest of the market simply catches up, driving indices even higher. That might sound somewhat Pollyannaish, but it is not too unreasonable when you consider what is driving gains.

I have been around long enough and am cynical enough to be wary of hyperbole, but when people say that AI is a truly revolutionary technology that is transforming the business world, it is hard to argue with that. It is going to result in huge improvements in efficiency and productivity when its full benefits are available to companies. However, we aren’t there yet.

At this point, for the other four hundred and ninety odd companies in the S&P 500, the AI revolution is a cost rather than a benefit. They are all sending their money to the few companies that have developed products they need to take advantage of the advances in computer technology, hence the disparity in performance.

That, however, is an investment in the future. And at some point, AI adoption will shift from being a cost to being a benefit for the buyers of the technology. When it does, there will be a coming together in terms of performance. That doesn’t mean that the likes of NVDA and MSFT will get hit hard. Their revenue growth may slow down a bit, but the main thing driving the equalization will be better results from AI’s users. In that scenario, the gap can be closed with the major indices moving higher, not lower.

None of this is guaranteed, of course. It could be that the benefits of AI are being overestimated, but it is hard to see how something that enables an employee to condense a 150 page report into a 15 minute presentation within minutes rather than days or weeks, cannot help but result in efficiencies and higher margins. That means higher salaries and capex spending or, to put it another way, economic growth.

While it might feel like we are heading for a collapse as just a handful of stocks drive big gains in the stock market indices, that isn’t necessarily the case. AI is truly revolutionary, and while adopting it it is currently sucking cash out of the majority of companies and handing it up to just a few, the benefits of that investment will be felt by the many before too long, so there could be a happy ending after all.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.