Goldman’s Warning: Market Concentration Now Exceeds Tech Bubble Peak

“The persistent outperformance of a handful of mega-cap stocks has supported the level of the S&P 500 index but raised investor concerns about narrow market breadth”, Goldman’s David Kostin writes, in a note dated Friday.

It’s a familiar refrain. Time and again over the course of the last several years, skeptics of the bull market argued that the rally rested on a shaky foundation – that too much of the burden fell on the shoulders of too few.

Those concerns were amplified in late 2019 and early in 2020, as big-cap tech touched the most overbought levels since the dot-com bust. Nearly everyone who hadn’t completely lost their minds was calling for a pullback.

Microsoft, Apple, Amazon and Google were all in the “$1 trillion club”, something Donald Trump celebrated on Twitter almost concurrent with an Economist cover to the same effect.

If ever there was a ringing of the proverbial bell at the top, this was it:

"If only there had been warning signs"…. pic.twitter.com/d3jLJ5GmSz

— Heisenberg Report (@heisenbergrpt) February 21, 2020

And yet, fast forward a few months and despite (or, in some sense, because of) the pandemic, the situation is even more acute from the perspective of tech dominance than it was pre-COVID.

“Coming into 2020, the five largest S&P 500 stocks accounted for 18% of index market cap, matching the share at the peak of the Tech Bubble in March 2000”, Goldman’s Kostin writes, before noting that “since then, those stocks (MSFT, AAPL, AMZN, GOOGL, FB) have risen to account for 20% of market cap”.

That, folks, is the highest concentration going back at least three decades. Although there are myriad ways to measure breadth, there is no recent precedent for this level of concentration among the five largest names.

(Goldman)

In short, we are right back in familiar territory, with strong balance sheets, growth, big-cap tech and anything seen as “quality” assuming leadership and, arguably, distorting things, amid the rebound off the late-March lows.

“Many market participants — ourselves included — have expressed incredulity at the fact that the S&P 500 trades just 17% below its all-time high amid the largest economic shock in nearly a century”, Goldman’s Kostin says, marveling at a state of affairs that some say only makes sense through the lens of policy support, both fiscal and monetary.

Previously, the bank argued this situation didn’t have to end badly as the sheer profitability of today’s market leaders may mean a repeat of the dot-com bust isn’t likely. And yet, it’s almost self-evidently true that the more extreme concentration gets, the more difficult it will be for the broader index to move higher in the absence of participation from at least some other names.

Kostin goes on to point out that the median S&P company is still trading 28% off its all-time highs, a full 11 percentage point disparity with the index itself. That makes for a one-standard deviation event in this particular measure of market breadth.

(Goldman)

To be sure, this can last a while. In the past, when market breadth (as measured by this method) narrows more than one standard deviation, the median length of time before resolution is around three months, Goldman says.

But it will resolve, make no mistake.

“Eventually, though, narrow market breadth is always resolved the same way”, Kostin says, adding the following:

Often, narrow rallies lead to large drawdowns as the handful of market leaders ultimately fail to generate enough fundamental earnings strength to justify elevated valuations and investor crowding. In these cases, the market leaders “catch down” to weaker peers. In other cases, an improving economic outlook and strengthening investor sentiment help laggards “catch up” to the market leaders.

I’ll leave it to you to decide which is more likely given the current “economic outlook”.