02/12/24 09:38 AM EST

Increasing Market Concentration Warning

Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

We will discuss it in much more detail in today's Tier1 webcast, but it's time to revisit the effects of market inelasticity. Here is a good primer to get you going.

This divergence manifests passive investing's influence and market inelasticity, where large inflows into index funds disproportionately benefit the largest stocks within the index, thus amplifying their market movements relative to smaller companies.

This is a fiercely debated topic, but the increase in market concentration is not disputed. Bears (and some bulls) will point to rising valuations in this group. In 2010, the top 10 stocks constituted 19% of the S&P 500's market cap and were responsible for around 19-20% of the index's earnings. By the end of January 2024, the top 10 stocks represented 32.5% of the index's market cap and still 20% of earnings. The most prominent companies have grown in market value more than their earnings growth, leading to increased valuation multiples despite rising interest rates.

The debate is whether this is an expected function of high-quality companies gaining market share with the potential for huge forward growth or whether this is a byproduct of the outsized effects of passive index investing, where money automatically flows into these stocks regardless of their earnings performance and largely beyond the market's capacity to absorb the flows. Regardless of your conclusion, this concentration raises questions about market structure and stability, as a significant portion of the index's performance and investor returns are tied to the fortunes of a small number of firms.

Learn more about the Market Situation Report written by Tier 1 Alpha.