With valuations at their highest level today since the dot-com boom, there’s concern about a flood of investors piling into large-cap tech companies, and some are warning that too much market concentration in a handful of stocks could pose downside risks.
Much of the stock market’s remarkable rebound from March’s coronavirus low point can be attributed to investors piling money into a handful of mega-cap tech stocks.
Shares of Apple, Microsoft, Amazon, Google and Facebook are soaring and leading the market higher in recent months.
While the S&P is down roughly 1% in 2020, Facebook and Google have jumped more than 10%, Apple and Microsoft are up 25% and Amazon has gained a whopping 57%.
Many investors view these big names as a safe haven, and they expect steady profits and revenue from online businesses despite uncertainty over the coronavirus pandemic, which has wreaked havoc on much of the rest of the market.
Today, these five companies together make up about 22% of the S&P 500 index today—the highest level on record, which has raised concerns on Wall Street about too much market concentration in a handful of stocks.
The concern is simple: a drop in their shares will often drag down the entire market—a pattern that has already been playing out over the last few weeks.
“The fact that these big tech stocks have been so strong is a sign of caution in the market—investors aren’t buying reopening stocks like airlines and cruises, for example,” says Adam Crisafulli, founder of Vital Knowledge.
“It’s not a sign of optimism….investors are looking at big tech stocks like they used to look at utilities: Strong business models and growth opportunities that are so vast that they will continue to thrive in this uncertain landscape,” he adds.
The rise of big tech stocks this year has in large part been driven by a surge of retail investors, explains Pierce Crosby, general manager of TradingView. In early February, big tech stocks were seen as a definite market leader, but the market tanked in March and value stocks made a comeback as investors rotated out of the high-growth, mega-cap tech stocks, he says. But in the last couple of months, especially since June, big tech has again been driving the market. “Winners beget more winning,” Crosby adds.
Some analysts say that investors don’t need to worry about any such market concentration: “Fortunately, you can cross ‘market concentration’ off your list of things to fret about,” Credit Suisse’s chief U.S. equity strategist, Jonathan Golub, said in a recent note. “There’s lots to worry about these days including an increase in COVID-19 cases, a strained relationship with the world’s #2 economy, ballooning deficits and the potential for higher taxes.” He notes that while today’s top five companies represent a bigger market share than during the dotcom bubble—when Microsoft, Cisco Systems, General Electric, Intel and Exxon Mobil made up about 18% of the S&P—they are still delivering stronger earnings growth, and contributing to more of the index’s profits overall.
As a group, today’s top five companies—Apple, Microsoft, Amazon, Google and Facebook—trade at 34.4 times earnings. Compared to the dot-com bubble in 2000, the five biggest companies back then traded at nearly 47 times earnings, Golub notes.
“I think the [tech] bubble has stopped inflating, but now it’s a question of when it starts deflating,” says Crisafulli. “The key consideration is where do people go if not into tech—and there’s no obvious candidate.”