TOO BIG, TOO FEW(?)
February 2025
PART THREE: QUO VADIS?
Ruan Goosen - Portfolio Manager
Reuben Beelders - CIO, Portfolio Manager
In this final instalment of our three-part series on overconcentration in global equity markets, we consider historical comparisons and future implications. While the current environment is supported by strong fundamentals and a proven history of innovation, history reminds us that even the most dominant market regimes eventually face forces likely to result in more balanced levels of concentration.
A review at previous periods of market concentration provides valuable insights. Take the Nifty Fifty of the 1960s and 1970s, a group of blue-chip companies like Coca-Cola, IBM, and McDonald's, hailed for their seemingly limitless growth potential. Investors at the time were willing to pay extraordinary multiples - 42 times earnings, for example, compared to 19 times for the broader market in 1972 - betting on future prosperity.
Today’s MAG7 stocks, though valued higher with forward earnings multiples of around 31 times compared to 24 times for the S&P 500, have much stronger fundamentals. Their net margins often exceed 20%, compared to roughly 10% among the Nifty Fifty companies, and they capture nearly 70% of the S&P 500’s economic profit. Despite these strengths, the example of the Nifty Fifty offers valuable lessons: after a period of overvaluation, these stocks underperformed the broader market by about 33% during a prolonged period of stagflation and market correction in the 1970s. However, some of these companies, like Coca-Cola, eventually provided strong long-term returns, showing the importance of lasting competitive advantages. That said, even though these companies provided sustainable long-term returns, Warren Buffet’s adage remains relevant: " The price you pay for a stock is critical. A too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favourable business developments." The same caution applies to the high valuations of the MAG7.
The dot-com bubble of the late 1990s and early 2000s offers another striking parallel. During that time, speculation around internet startups drove the Nasdaq to surge by as much as 800% from 1995 to 2000, only to experience a dramatic collapse that wiped out 78% of its value in the following years. While technology stocks play a similarly prominent role in today’s market, the current environment is notably different. Although valuations are elevated, they are far more reasonable. For example, while companies like Cisco once traded at eye-popping multiples near 125 times forward earnings, the MAG7 today average around 31 times forward earnings, indicating a more “disciplined” approach. Additionally, whereas only a minority of dot-com era IPOs were profitable, today’s market leaders combine strong profitability with a staggering $1.6 trillion in combined revenue as of 2024. Despite these differences, the parallels remind us that even dominant sectors can face sudden shifts if underlying fundamentals fail to support high valuations.
Looking ahead, the future trajectory of U.S. equity concentration is likely to be shaped by a convergence of macroeconomic trends, regulatory developments, and shifts in investor behaviour. An industrial recovery could potentially catalyse a broader market resurgence. For example, Goldman Sachs forecasts capex growth to accelerate next year and grow ~2.6 times faster than U.S. GDP, an event that has historically been associated with the outperformance of cyclical sectors such as industrials and materials. Moreover, a resurgence in small-cap performance is not unheard-of during periods of economic strength, as smaller firms tend to outpace larger ones when industrial activity accelerates.
Meanwhile, an upswing in mergers and acquisitions could further redistribute market leadership. With corporate strategies pivoting in response to evolving economic conditions and regulatory relaxations, an anticipated surge in M&A activity—potentially rising more than 20%—might channel capital towards mid-cap and undervalued sectors such as energy and utilities. This shift would not only diversify market exposure but could also help narrow the concentration gap that currently characterizes the U.S. equity landscape.
Policy dynamics and global monetary conditions are poised to play significant roles as well. In an environment where pro-business policies, including tax incentives and deregulation, are gaining traction, sectors like financials and energy could receive a much-needed boost. Additionally, coordinated rate cuts by the majority of central banks worldwide are expected to provide an extra layer of liquidity, even as the Federal Reserve approaches its policy decisions with caution. At the same time, analysts forecast that the remarkable earnings growth of the MAG7—peaking at around 37% in 2023—might decelerate to approximately 3% in 2025, potentially levelling the playing field for other sectors such as healthcare and industrials.
However, these forward-looking catalysts come with inherent risks. One of the biggest concerns is the possibility that valuations remain at extreme levels. The cyclically adjusted Shiller PE ratio for the S&P 500 is currently around 37, which, if it stays this high, could indicate a decade of modest returns, similar to the "lost decade" in previous cycles. The MAG7’s premium, trading at 31 times forward earnings compared to 24 times for the broader market, requires continued high growth - around 15% annually through 2030 - to be justified. Achieving such growth may become increasingly difficult in an environment of rising regulatory scrutiny and intense competitive pressures.
As discussed in Part 2, the dominance of passive investing further complicates the situation. With passive funds now managing nearly $15 trillion in assets and automatically directing a large portion of inflows toward the biggest stocks, a self-reinforcing cycle is at play. This trend could delay the natural rebalancing process, even if the fundamentals of mega-cap companies start to weaken, potentially increasing market volatility.
Geopolitical and policy uncertainties add further complexity. Increased antitrust actions, especially against Big Tech, and rising tensions between the U.S. and China pose risks that were largely absent in earlier periods. These factors, along with the potential for crowded institutional positioning—where current equity allocations are well above the 25-year average—could lead to cascading selloffs if the market faces a downturn.
Compounding these challenges is the competitive landscape, particularly in technology. The rapid advancements in fields like artificial intelligence and machine learning is changing traditional market structures. A prime example is the impact of DeepSeek’s release of a low-cost AI model, which caused Nvidia’s stock price to drop 16.9% in January 2025, wiping out hundreds of billions in market value overnight. This illustrates how quickly competitive dynamics can shift. Consequently, even the established giants must continuously invest in research and development, leading to higher capital expenditures and long-term pressure on profit margins.
As we stand at this potential tipping point, the lessons of the past remind us that concentration alone is not a market bubble. Rather, it is a dynamic state that requires rigorous vigilance. For investors, the key is to balance embracing technological innovation and market leadership with prudent risk management. Diversification - across sectors and geographies - becomes a vital to mitigating the risks of an overconcentrated market. At the same time, it remains essential to closely monitor triggers such as a slowdown in MAG7 earnings, shifts in Fed policy, or changes in passive investment flows.
In conclusion, while the MAG7 continue to lead innovation and drive market performance, their future depends on navigating a complex mix of economic, regulatory, and competitive challenges. As the adage goes, “It’s only when the tide goes out that you learn who’s been swimming naked.”
The years ahead will test market leaders and the resilience of portfolios dependant on them. The key remains staying agile and informed, maintaining a properly diversified investment strategy that adapts to a capricious market.
“The four most dangerous words in investing are: ‘This time it’s different.’” Sir John Templeton