Just how concentrated is the US equity market?

Well, the most concentrated ever on at least a couple of measures.

The narrow market bear narrative is ubiquitous to the point of being ad nauseam by now, but this is a case where failing to pound the table (or beat the proverbial dead horse) risks underemphasizing what may be remembered as one of the more egregious distortions to confront market participants since the dot-com bust.

That’s not an exaggeration. On Monday, Morgan Stanley’s Mike Wilson described the situation as “unprecedented.” He was referring to the top five stocks’ combined index weighting and the Herfindahl-Hirschman Index, both illustrated below.

As you can see, the trajectory of recent developments has no precedent. Market concentration has risen at least as steeply as it did during the stay-at-home tech bubble, and in a much more compressed time frame.

At the risk of trafficking in the sort of nebulous clichés I so abhor (e.g., “Something’s gotta give”), it’s exceedingly difficult to understand how this is sustainable.

The good news is, a resolution needn’t entail a bearish outcome at all. As Wilson pointed out, “the positive interpretation is that a reversion in these trends from extreme levels will be the fuel for the next bull as the concentration of investment broadens out to the rest of the market.”

Indeed, Wilson described that outcome as generally consistent with his own thinking, or at least with how he believes things will unfold once the market gets beyond a possibly imminent pullback tied to the realization of earnings downside. “Capital should eventually re-allocate to other opportunities once the risk of the slowdown is priced or extinguished and the new growth cycle is closer,” he remarked.

Meanwhile, RBC’s Lori Calvasina seemed to suggest that concentrating on concentration (if you will) in an effort to divine something about the cycle or forward returns could be more trouble than it’s worth.

“Sometimes high concentration has been seen heading into market stress (2000, 2021). Sometimes, high concentration has been seen in the middle of market stress (GFC). Sometimes, high concentration has come after market stress when confidence was still fragile (1991, 2012),” she wrote, adding that “when only a handful of stocks are making new 52-week highs, more often than not stocks solidly are up 12 months later.”