Stock market concentration now in the level of great depression

Is his­to­ry going to repeat itself? Well… the answer isn’t that straightforward.

Stock mar­ket con­cen­tra­tion refers to the degree to which a small num­ber of com­pa­nies or stocks dom­i­nate the total mar­ket cap­i­tal­iza­tion or trad­ing vol­ume of a stock mar­ket. High con­cen­tra­tion means that a few large com­pa­nies have a sig­nif­i­cant impact on the over­all mar­ket per­for­mance, while low con­cen­tra­tion indi­cates a more even dis­tri­b­u­tion of mar­ket influ­ence among a larg­er num­ber of companies.

Key aspects of stock mar­ket con­cen­tra­tion include:

●Mar­ket Cap­i­tal­iza­tion Con­cen­tra­tion: The extent to which the total mar­ket val­ue of a stock mar­ket is dom­i­nat­ed by a few large companies.

●Trad­ing Vol­ume Con­cen­tra­tion: The pro­por­tion of total trad­ing vol­ume account­ed for by a small num­ber of stocks.

●Sec­tor Con­cen­tra­tion: The degree to which spe­cif­ic indus­try sec­tors dom­i­nate the stock market.

In this arti­cle, we use the term ‘stock mar­ket con­cen­tra­tion’ to refer to mar­ket cap­i­tal­iza­tion con­cen­tra­tion. Mar­ket cap­i­tal­iza­tion con­cen­tra­tion is par­tic­u­lar­ly sig­nif­i­cant for the econ­o­my for sev­er­al reasons:

Eco­nom­ic Rep­re­sen­ta­tion: Large com­pa­nies with sig­nif­i­cant mar­ket cap­i­tal­iza­tion often rep­re­sent key sec­tors of the econ­o­my. Their per­for­mance can reflect the over­all eco­nom­ic health. For instance, if tech giants dom­i­nate the mar­ket, their growth or decline can sig­nif­i­cant­ly impact eco­nom­ic indicators.

Invest­ment Flows: High mar­ket cap con­cen­tra­tion can direct a large por­tion of invest­ment flows toward a few com­pa­nies. This can cre­ate a feed­back loop where these com­pa­nies receive more cap­i­tal, fur­ther increas­ing their mar­ket dom­i­nance and poten­tial­ly cre­at­ing mar­ket imbalances.

Mar­ket Sta­bil­i­ty: A high­ly con­cen­trat­ed mar­ket can be more volatile. If the few dom­i­nant com­pa­nies face finan­cial trou­bles or sec­tor-spe­cif­ic down­turns, it can lead to sig­nif­i­cant mar­ket declines, affect­ing investor con­fi­dence and eco­nom­ic stability.

Impact on Small­er Com­pa­nies: High con­cen­tra­tion can make it dif­fi­cult for small­er com­pa­nies to attract invest­ment, sti­fling inno­va­tion and growth in less dom­i­nant sec­tors of the econ­o­my. This can lead to a less dynam­ic eco­nom­ic environment.

Reduced Mar­ket Breadth: High con­cen­tra­tion implies that a small­er num­ber of stocks con­tribute to mar­ket move­ments. This can reduce the mar­ket’s over­all breadth, mak­ing it less rep­re­sen­ta­tive of the broad­er econ­o­my. Investors might find few­er oppor­tu­ni­ties for diver­si­fi­ca­tion, lead­ing to high­er risk in invest­ment portfolios.

Top Decile vs Second Tier Concentration

As of now, the ten lead­ing stocks, includ­ing the notable “Mag­nif­i­cent 7” — Alpha­bet, Ama­zon, Apple, Meta Plat­forms, Microsoft, Nvidia, and Tes­la — each sur­pass­ing a mar­ket val­ue of $1 tril­lion, col­lec­tive­ly com­prise about 32% of the total mar­ket val­ue. This is well above the 27% share reached at the peak of the tech bub­ble in 2000, a peri­od char­ac­ter­ized by a surge in the NASDAQ Com­pos­ite Index, which soared by 400% from 1995 to its peak in March 2000, only to plum­met by near­ly 78% over the next two years as the bub­ble burst.

It’s no secret that the 7 tech giants have been fuel­ing the cur­rent bull­ish mar­ket trend. Between Jan­u­ary 2023 and April 2024, the stocks of the “Big 6 TECH+” com­pa­nies — Apple, Ama­zon, Google, Meta, Microsoft, and Nvidia — rose by 117%. These com­pa­nies include all but one of the Mag Sev­en stocks, exclud­ing Tes­la. Key finan­cial health indi­ca­tors, such as earn­ings per share (EPS), val­u­a­tion mul­ti­ples, and growth expec­ta­tions are heav­i­ly influ­enced by these com­pa­nies, which account for 25% of earn­ings. In late 2023, the 7s made up almost 44% of its top 10 hold­ings and trad­ed at an aver­age P/E ratio over 50, more than dou­ble the S&P 500’s ratio of just over 20 and near­ly twice the Nas­daq 100’s ratio of around 28.

Top vs. Mid-Tier Concentration

Now, it becomes more con­cern­ing when we con­sid­er ‘con­cen­tra­tion’ as the mar­ket cap of the largest stock rel­a­tive to the 75th per­centile stock. From this per­spec­tive, the cur­rent lev­el of stock mar­ket con­cen­tra­tion is notably sim­i­lar to that seen dur­ing the Great Depres­sion era.

The years point­ed out in the chart below cor­re­spond to sig­nif­i­cant peri­ods in eco­nom­ic and mar­ket history: 

1932: This was dur­ing the Great Depres­sion era, marked by severe eco­nom­ic down­turn and mar­ket insta­bil­i­ty fol­low­ing the 1929 stock mar­ket crash
1964: This peri­od saw eco­nom­ic expan­sion in the Unit­ed States, part of the post-World War II eco­nom­ic boom.
1973: This year marked the begin­ning of a severe reces­sion due to the oil cri­sis, which led to eco­nom­ic chal­lenges glob­al­ly.
2000: This cor­re­sponds to the dot-com bub­ble burst, where exces­sive spec­u­la­tion in tech­nol­o­gy stocks led to a mar­ket down­turn
2009: Fol­low­ing the 2008 finan­cial cri­sis, this year was a recov­ery peri­od marked by sig­nif­i­cant gov­ern­ment inter­ven­tions to sta­bi­lize the econ­o­my.
2020: The onset of the COVID-19 pan­dem­ic trig­gered a glob­al eco­nom­ic down­turn and stock mar­ket volatility.

Observ­ing the mar­ket cap of the top stock com­pared to the 75th per­centile stock reveals impor­tant insights. It under­scores which sec­tors or indus­tries are dri­ving a sig­nif­i­cant por­tion of the mar­ket’s total cap­i­tal­iza­tion. If the top stock is from a spe­cif­ic sec­tor and its mar­ket cap far exceeds that of the 75th per­centile stock, it indi­cates that sec­tor’s out­sized influ­ence on over­all mar­ket val­u­a­tion. Sec­tor-spe­cif­ic issues, such as reg­u­la­to­ry changes or tech­no­log­i­cal dis­rup­tions, can dis­pro­por­tion­ate­ly affect the entire mar­ket’s per­for­mance. It also indi­cates that eco­nom­ic pow­er is con­cen­trat­ed in a few large com­pa­nies. Dom­i­nant com­pa­nies might have more pric­ing pow­er, influ­ence over sup­pli­ers and dis­trib­u­tors, and greater abil­i­ty to set indus­try standards.

Giv­en the con­cern­ing chart com­par­ing the his­tor­i­cal lev­els of the top stock to the 75th per­centile stock, it rais­es a crit­i­cal ques­tion: is this a sign of anoth­er depres­sion? To answer that, we must revis­it the ear­ly 20th century.

The Great Depression: Causes and Consequences

From before the Great Depres­sion through its after­math and into sub­se­quent years, the mar­ket was dom­i­nat­ed by a few large com­pa­nies and sec­tors, includ­ing Gen­er­al Elec­tric (GE), Gen­er­al Motors (GM), U.S. Steel, Coca-Cola and Sears.

When one in twen­ty Amer­i­cans were a share­hold­er in the ear­ly 1920s, the fig­ure had risen to one in six by 1929. The pre-crash years were char­ac­ter­ized by a craze for mak­ing quick mon­ey, and the best option for doing so was the stock mar­ket. Pop­u­lar stocks were over­val­ued, and the mar­ket expe­ri­enced a 37.88% annu­al increase in 1928. The peak was observed on Sep­tem­ber 3rd, under­scored by the Dow Jones Indus­tri­al Aver­age hit­ting a record high of 381.2 points.

Mar­gin trad­ing great­ly height­ened mar­ket fragili­ty. This left investors heav­i­ly indebt­ed and vul­ner­a­ble to mar­ket swings. As stock prices plunged, investors faced mar­gin calls, neces­si­tat­ing the sale of stocks at reduced prices to cov­er debts, exac­er­bat­ing mar­ket turmoil.

From Sep­tem­ber 1 to Novem­ber 30, 1929, the stock mar­ket lost over half of its val­ue, from $64 bil­lion to around $30 bil­lion. The col­lapse of the stock mar­ket rever­ber­at­ed through the bank­ing sec­tor, with inter­con­nect­ed banks suf­fer­ing sig­nif­i­cant loss­es from their stock invest­ments. This inter­con­nect­ed­ness led to a domi­no effect of bank fail­ures. These fail­ures erod­ed pub­lic con­fi­dence and sparked wide­spread bank runs, which fur­ther deep­ened the crisis.

Ulti­mate­ly, it was the over­val­u­a­tion, not con­cen­tra­tion, that was iden­ti­fied as a major cause of the Great Depres­sion’s trig­ger­ing crash.

Fol­low­ing the crash, there was a sig­nif­i­cant decline over the next cou­ple of years, with drops of 28.48% in 1930, and 47.07% in 1931. And just a year lat­er, in 1932, stock mar­ket con­cen­tra­tion reached its zenith, with the lead­ing stock­’s mar­ket cap sur­pass­ing that of the 75th per­centile stock by over 700 times.

Economic Instability Isn’t Always Linked to Market Concentration

Over the past two cen­turies, the U.S. stock mar­ket has expe­ri­enced vary­ing degrees of con­cen­tra­tion among its top com­pa­nies. Despite recent trends show­ing increas­ing con­cen­tra­tion, his­tor­i­cal data sug­gests that such con­cen­tra­tion does not inevitably lead to eco­nom­ic depres­sion. Bryan Tay­lor, Chief Econ­o­mist at Glob­al Finan­cial Data, pro­vides an in-depth analy­sis of this phe­nom­e­non across dis­tinct his­tor­i­cal periods.

From 1790 to 1840, the U.S. stock mar­ket was dom­i­nat­ed by the First and Sec­ond Banks of the Unit­ed States, which con­trolled a sig­nif­i­cant share of mar­ket cap­i­tal­iza­tion. How­ev­er, as more com­pa­nies were estab­lished, their dom­i­nance waned.

The peri­od from 1840 to 1875 saw the rise of rail­roads as the dom­i­nant sec­tor, with the Ver­mont Cen­tral Rail­road being the largest com­pa­ny in 1845. By the end of the Civ­il War, trans­porta­tion com­pa­nies made up the top ten largest com­pa­nies, rep­re­sent­ing over 20% of the stock mar­ket. The Amer­i­can Com­mer­cial Rev­o­lu­tion from 1875 to 1929 intro­duced new indus­tries like elec­tric util­i­ties, depart­ment stores, and auto­mo­bile man­u­fac­tur­ers, which diver­si­fied the market.

Speak­ing of recent times, the con­cen­tra­tion has increased sig­nif­i­cant­ly due to the rapid inte­gra­tion of new tech­nolo­gies, which has favored large-cap stocks. While the lev­el of con­cen­tra­tion may ini­tial­ly raise concerns—especially as top-ver­sus-mid-tier con­cen­tra­tion has now reached lev­els not seen since the Great Depres­sion, evok­ing mem­o­ries of 1929—it alone is not nec­es­sar­i­ly indica­tive of anoth­er mar­ket crash, but it does not rule any­thing out either.

Nev­er­the­less, the cat­a­stroph­ic Great Depres­sion was not sole­ly the con­se­quence of stock mar­ket con­cen­tra­tion; it was influ­enced by mul­ti­ple fac­tors, includ­ing mis­steps by the Fed­er­al Reserve, over­sup­ply, over­pro­duc­tion, under-con­sump­tion, and bank­ing fail­ures. In the mid-1920, 28,885 banks were in oper­a­tion. At the end of 1929, the num­ber of banks had declined to 23,712 (_{^{Fed­er­al Reserve Board, 1932, p. 53}})