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Indexes were originally created to track and analyze the market, so it’s not surprising that even index investors like to use their data to predict, or speculate, on the next market move. Among all the bits of collected ancient wisdom—and myths—around indexes is the belief that as the market becomes more concentrated at the top, the chance of a sharp downward break increases. We can make this operational by looking at the S&P 500 and how much of the index’s total market value is accounted for by the 50 largest stocks; the analysis reveals this bit of wisdom has some truth to it, although its utility as a market forecaster is limited at best.
Figure 1 shows the S&P 500 and the share of the 50 largest stocks in the index from 1989 through April 2010 using month-end data. The 50-largest share varies from 45 to 60 percent over time. It peaks in early 2000 when the tech stocks began to collapse. Had one been tracking the 50-largest share during the last half of the 1990s, it should have given signs that all was not well in the market. Of course, neither this statistic nor most others available would have cooled all the euphoria that swept the Internet market.
More recently, the 50-largest share surged upward in September 2008, as the market crumbled in the face of the financial crisis and then turned down in March 2009 as the market bottomed. The downward drift beginning in 2003, which took the share under 50 percent, suggests that the stock market did not anticipate a market slide or the financial crisis until disaster was upon it in 2007.
The largest-50 share data poses questions about the market: Was there something very different about the 1990s tech bull market and the rebound from the 2000-2002 bear market? Why does concentration rise in a bubble?
The Tech Boom And The Mid-2000s Market
The second half of the 1990s was driven by tech stocks and growth stocks. The tech sector share of the S&P 500 climbed from 8.5 percent in January 1995 to a peak of 33.1 percent in February 2000. This was largely the result of market movements, not changes to the stocks in the benchmark. The guidelines S&P uses in selecting stocks for the S&P 500 Index require that stocks have four quarters of positive earnings when added to the index. Many of the Internet story stocks of the 1990s barely had a year of revenues, to say nothing of earnings, so they weren’t possible candidates for the index. AOL, then a darling of the moment, didn’t join the index until the end of 1998. The 1990s bull market was a technology market and little else. Among the 10 sectors, only one other—financials—gained share: Financials rose 0.8 percentage points, while technology rose 24.6 percentage points. The health care sector share was unchanged and the other sectors all lost share. Even telecommunication services, often linked to technology, lost 1.3 percentage points of share.
The mid-2000s market was different. Technology and financials both gained share from October 2002 to July 2007, but more modestly; tech gained 9 percentage points, financials 8.2 percentage points. Energy and health care also gained share, while the other sectors lost. The range from top gainer to biggest loser in the 2000s market was 14.9 percentage points, compared with 31.3 points in the 1990s bull market. While the 1990s were a tech bubble, the mid-2000s were a more general market recovery. The more recent market was not solely dependent on booming bank stocks.
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