The Concentration Problem

February 9, 2022

Stocks have had a rough start to 2022. After a quick sell-off and then a bit of a bounce-back, the S&P 500 is down roughly 5%, and the NASDAQ is down roughly 9%. The selling took a pause when the largest members of the stock market reported their earnings. Microsoft, Apple, Google, Facebook, and Amazon all reported their earnings in a two-week span covering the last week of January through the first week of February. Each earnings release had different levels of uncertainty, but volatility was elevated quite a bit around each one. Microsoft’s earnings were first, the least uncertain of the group, and came out fairly in line with expectations, posting strong results. Nothing to worry about so far. Apple came next. Apple was the first of the bunch that saw notable volatility leading up to their earnings. Given the circumstances, it was hard to know what to expect. Apple hadn’t provided guidance in the previous earnings, and it was hard to know how much of an impact the 4th quarter demand slowdown would impact them. Fortunately, Apple posted better than expected results, surprising a lot of investors, and temporarily calming the storm. Next up was Google, and like Microsoft, their earnings were a lot more predictable. We saw minimal volatility leading up to the release, and the strong results eased the selling pressure. Then Facebook reported its earnings. Facebook’s earnings came out below expectations, not the first time that has happened, but this time the reasoning for why the earnings were lower was more significant. The first hit was the resulting impact of the recent iPhone privacy change. When Apple first announced that they would be limiting data tracking, it was hard to know how that would impact companies like Facebook that rely on data. Now we know that it’s not pretty. A significant cut to Facebook’s revenue was attributed to this iPhone policy change. The second, and probably more significant hit to the business, is that their user growth is well below what it has been historically. At this point, Facebook is considered a mature business. It is getting harder and harder for them to add users to their platforms. With these headwinds in place, I have been hearing that it’s entirely possible that Facebook’s main business lines won’t grow anymore. If that’s the case, then their path forward rests upon their bet on the metaverse, and who knows if the metaverse will even take off. The main thing to know is that their path to growth has shifted from them expanding the more stable and predictable core parts of their business to expanding the more speculative component of the business, creating a lot more uncertainty about their future growth prospects. Following this news, Facebook’s stock price gapped down significantly, resulting in the largest single-day dollar loss in an individual stock in market history. Next up, Amazon’s earnings. Leading up to it, the major US indices were down quite a bit after the Facebook results and over the uncertainty surrounding Amazon. If we saw something like Facebook’s results, it would be almost a guarantee we would head into a bear market. Amazon reported their results, and they were, fortunately, very strong, stronger than what was expected. The stock market gets to breathe another day.

The stock market may have come away relatively unscathed following this bout of earnings releases, but the main takeaway is that we find ourselves in a highly concentrated, and therefore, highly fragile market environment. The concentration of the top 10 stocks in the S&P 500 is near an all-time high. The top 10 stocks now make up almost a third of the total capitalization of the S&P 500. The last time we saw this level of concentration was several decades ago. This means that any weakness seen in any of these top 10 names will have a sizeable impact on the overall index.

Source: FactSet, Standard & Poor's, J.P. Morgan Asset Management

Opportunities exist outside of the top 10, but if you look at the dynamics we have had over the last decade, the top 10 stocks have been making up most of the returns of the US stock market. Unless we expect a regime change, which is entirely possible and shouldn’t be discounted, what we find ourselves in is an environment of, “you can’t win with them, but you can’t win without them.” All this leads us to continue to favor non-US markets that have healthier, broader market dynamics that won’t be heavily influenced by the results of individual companies.

< Back to Insights