‘American Exceptionalism’ is the new buzz word in global markets.
An economy that has not just defied recession predictions for two years in a row amidst significant tightening of interest rates by the Federal Reserve, but has also grown much stronger than estimated and as compared to other developed countries.
Add to it the AI revolution, and an upcoming Trump Presidency, ‘caution’ appears to be a word that does not exist in the dictionary any more for investors betting on US stocks.
While last week was turbulent for US markets, as the Fed gave a hawkish message, it was just a blip considering the stellar returns delivered in the last two calendar years after the bear market in the S&P 500 and Nasdaq Composite bottomed out in 2022. The YTD (year-to-date) return of 25 per cent in S&P 500 and 32 per cent in Nasdaq Composite ramps up the returns from start of 2023 (when recession was the consensus prediction of economists) to a stellar 55 and 87 per cent, respectively.
However, amidst the euphoria over ‘American Exceptionalism’, lies a structural risk.
Market concentration
Of the 55 per cent gains in S&P 500 since the start of 2023, 36 percentage points have been delivered by just 10 stocks.
In other words, around 65 per cent of the gains made by the index has been delivered by 2 per cent of the stocks. This has resulted in a level of market concentration never witnessed before, not even during the dotcom mania.
The top 10 stocks consisting of the Magnificent Seven stocks — Apple, Alphabet, Amazon, Meta Platforms, Microsoft, Nvidia, Tesla — and 3 others — Broadcom, Berkshire Hathaway and Walmart — together account for a staggering 39 per cent of the S&P 500 total market-cap today. This is nearly double of what it was 10 years back.
In the pre-Covid era, the highest level of concentration was witnessed during the dotcom boom, in March 2000, when the top 10 stocks of the S&P 500 accounted for 27 per cent of the total market-cap.
During the peak of the market bubble in October 2007, the market concentration was at 18 per cent.
The structural risk here is that with eight of the top 10 being technology companies (although it is being debated whether Tesla is a tech or an auto company), that form the fulcrum of the AI revolution with massive AI monetisation prospects loaded into their valuations, their shares have now become too big to fail.
Not fail in terms of business (as the big banks did in 2008), but when it comes to meeting expectations.
Any hiccups in the long- run path to ubiquitous AI and its monetisation, as it happened during the Internet revolution in 2000 and 2001, can have severe ramifications for US and global markets.
With so many investors betting so much on just 2 per cent of the S&P 500, this is key risk that investors looking to enter the US markets now must take cognisance of.
Historically, such levels of dominance of a few stocks has not ended well for the markets.