MFS Investment Management recently published an article entitled “The Other Side of Market Concentration Peaks” which discusses concentration cycles as well as diversification cycles in the stock market. A stock market concentration cycle refers to a pattern in which, over time, a particular segment of the stock market becomes increasingly concentrated with a few companies or sectors become dominant. As you can see from the chart below, the Top 10% of U.S. Companies account for nearly 75% of the market capitalization of the entire U.S. stock market. Although concentration cycles are not inherently a bad thing and although we do not know how long this one will last. We do know three things 1) this concentration cycle is the longest in history 2) they do not last forever and 3) according to MFS, the current one we are in has lasted 17.7 years, the next longest being 15.3 years with the average being 10.3 years.
Eventually, concentration cycles are followed by diversification cycles – where the leaders become the laggards and the market broadens out. According to MFS, during these cycles, indexes whose components are weighted equally outperform those whose weighting is determined by their market capitalization by 50%. Furthermore, small cap outperforms large cap by 61% and value outperforms growth by 44%, these over a three-year period.
The so-called “Magnificent 7” (MSFT, AAPL, GOOGL, AMZN, META, NVDA, TSLA) have led the market and added tremendous wealth to the portfolios of our clients over the past decade-plus. It is therefore easy to fall into the trap of questioning why then, should one have a diverse portfolio. However, portfolio construction and long-term success in the stock market is achieved through building a portfolio that works through different market cycles. This includes investing in companies within several sectors to prevent against ending up with an overly concentrated portfolio, resulting in stagnation even while the broader indexes advance.
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