Wall Street for Dummies Feb 21, 2025

According to a small gaggle of self-appointed fortune tellers in the financial media, the market is on the verge of a horrific collapse, hurling all non-believers into a fiery pit. The cause of this rapidly approaching market apocalypse is the S&P 500’s concentration in the magnificent Seven; Apple, Amazon, Google, Facebook, Microsoft, Nvidia, and Tesla. Last year, more than half of the S&P 500’s 26 percent gain came from these seven companies. ?

I am not now, nor will I ever be, a market predictor. But I am mesmerized by those who claim to be. As Abe Lincoln said, “You can fool some of the people all the time, and all the people some of the time, and that’s enough to make a decent living.”

This brings back memories of Joe Granville, who every year from 1970 to 1989, predicted that the market was on the verge of a meltdown of epic proportions. On Black Monday in 1989, the market dropped 34 percent in two hours, allowing Granville to proclaim to the investing public, “Told ya so!!” His first, last and only moment in the sun.

Market concentration in a small number of companies is nothing new. The original Dow Jones Industrial Average consisted of just 12 stocks. All of them railroad companies. In the decade leading up to the Crash of 1929, Wall Street banks constituted 37 percent of the markets total value. In the early 1990s, Coke Cola, Phillip Morris, American Express, and General Motors dominated the indexes and created one of history’s most powerful bull markets. In the early 2000s, the market soared, powered by the internet pioneers Google, Microsoft and Intel.

The point that all these near-sighted forecasters miss is the way that indexes are constructed and maintained. The S&P 500 and Nasdaq are weighted by a company’s total market value. This means that the companies with the highest market cap have a disproportionate influence on the index’s movement. But as a company’s stock price fluctuates, so does their market value. On a regular basis, the companies that manufacture the S&P and Nasdaq, adjust a stocks weighting in order to reflect their current market value. Thus, when one company stumbles, another takes its place at the head of the pack. This cushions the market from one companies’ meltdown.

Another index characteristic overlooked by the aforementioned fortunetellers is the fact that stock returns are skewed to the upside. Losers can only go to zero, while winners can grow to infinity. It’s not a market negative for breakthrough companies to grow at double, or even triple, digit rates.?

A recent article in the WSJ provided a comment which I think brings this discussion to a rational conclusion. And I quote: “the only sensible conclusion is that there is no specific level of concentration at which the biggest stocks are so big that they send the risk sky high.”

For more on the Magnificent 7, go to my podcast, “Wall Street for Dummies.”

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