1932 was the same! High concentration in the US stock market is not scary; the real danger is being too expensive

On Wednesday, Robert Armstrong, a columnist for the Financial Times, published an in-depth article about the concentration of the U.S. stock market. The article discusses the phenomenon of the current U.S. stock market being highly concentrated in a few tech giants and whether this concentration truly indicates an increase in market risk.

Armstrong begins by describing a rather dramatic market day: after the AI company Anthropic launched a new legal work automation tool, the stock prices of software and professional services companies plummeted by over 3%, but the tech giants were not spared either; instead, traditional economic sectors such as energy, telecommunications, consumer goods, and materials emerged as winners. This example illustrates that the market landscape is changing.

Armstrong's core argument is: Market concentration itself is not frightening; what truly needs to be watched is high valuation. Although the Mag7 tech stocks no longer dominate the market as they did a few months ago, the concentration of the S&P 500 index remains high. More importantly, historical data shows that this concentration is not an abnormal phenomenon; a similar situation occurred in 1932.

Market Concentration: Six Companies Account for One-Third

How concentrated is the current U.S. stock market? Armstrong provides detailed data. Just six companies contribute to one-third of the total market capitalization of the S&P 500 index, with Nvidia alone accounting for 7%. If we look at the top 62 largest companies, they collectively account for two-thirds of the entire index's market value.

From a net profit perspective, the situation is slightly different but essentially similar. The six giants contribute 27% of net profits, while the top 62 companies contribute 63% of net profits. Armstrong points out that this means the largest companies often have "higher valuations—price-to-earnings ratios" compared to smaller companies.

This concentration has raised a question that many analysts are asking: Does the high concentration of market capitalization make the market more dangerous? Should investors reduce their allocation to the largest companies or industries relative to market weight?

History Tells Us: Concentration is the Norm

Armstrong notes that research papers by scholars Per Bye, Jens Soerlie Kvaerner, and Bas Werker provide compelling historical evidence. They analyzed data from all companies traded on major U.S. exchanges since 1926, including market capitalization and various profit indicators.

The findings are quite surprising. The authors of the paper write:

The relative importance of the Mag7 is not particularly special. For example, from the 1930s to the 1960s, seven companies held a similar share. "The peak occurred in May 1932, when AT&T, Standard Oil, New York United Gas Company, General Motors, DuPont, Reynolds Tobacco, and United Gas Improvement Company collectively accounted for about one-third of the total market capitalization."

This indicates that market concentration is not a phenomenon unique to modern times, nor is it a special product of the tech era. The same concentration pattern existed in the industrial age. In other words, the dominance of a few large companies in the market seems to be a norm in capital markets. The research also revealed an important finding: company fundamentals (such as revenue and profit) do indeed track changes in market capitalization concentration, but this correlation is relatively loose and exhibits cyclical fluctuations.

The paper also points out that when market capitalization concentration reaches an extreme (i.e., the number of companies accounting for one-third of total market capitalization drops to a historical low, currently less than 0.5%), the share of these largest companies in total revenue, profit, and cash flow is actually at a historical low, about one-fifth.

So, does high concentration also indicate low long-term returns? The paper states:

When viewed in isolation, market concentration does indeed have a negative predictive effect on returns (high concentration, low subsequent returns), but this is not the case when controlling for valuation factors... With valuations held constant, higher concentration is actually associated with higher future returns!

Mathematical Model Confirms: Concentration is a Natural Result

The second part of the paper further reinforces the argument that market concentration is a normal phenomenon using a mathematical model. The study employed a model "based on standard geometric Brownian motion diffusion processes," incorporating "common market factors and company-specific shocks."

Specifically, in this model, returns follow a random process. One can imagine a company's market capitalization as being continuously influenced by various shocks—productivity and innovation shocks, good or bad leadership, luck, and misfortune. Over time, most companies remain small (their positive and negative shocks offset each other), while a few companies receive a large number of positive shocks and grow into giants.

To use a metaphor, the stock market is like an ongoing dice game. Most players' results will tend to average out, but there are always a few players who are particularly lucky and roll good numbers consecutively. This is not surprising; it is a natural result of probability. Similarly, market concentration is also a result of the natural operation of market mechanisms