Issue 131

EAR TO THE GROUND

Paul Milburn, Lowes Investment Manager

‘Made from concentrate’

For other investors, however, the level of concentration seen in the top ten stocks means that the destiny of the movement in the index rests in too few hands. There are worries about a loss of diversification and concerns that inflows into index funds have contributed to the bidding up of a handful of stocks. At present, the focus is on the US, perhaps due to the dominance of the Artificial Intelligence (AI) theme within those top ten names. As our research shows, however, it is not only the S&P 500 where we currently see elevated concentration levels. In terms of the top 10 stocks, the Swiss market is even more concentrated, at 73.19% of the index, an index which includes 230 issues. It is not just at the stock level where we see concentration here, but sector level also. The health care sector accounts for 34.7% whilst the food & beverage sector is a further 21.5%. The FTSE All Share also has a top 10 stock exposure level which is greater than that seen in the S&P 500, at just over 40%. There is argument here, however, that sector concentration is not as dominant as that seen in the Swiss market, and there is no dominating theme, like that of AI in the US. Perhaps one area of the UK equity market where there is a greater level of concentration is when it comes to dividend payments. According to the Computershare Q1 2024 Dividend Monitor, 48% of total dividend paid in 2023 came from only five stocks, with the top 15 payers accounting for 83%. 2023 was by no means a one off either, with the top 15 dividend payers for 2019 through 2022 accounting for between 81% and 88%. So, are concerns justified or unwarranted? Those investors who have been allocated to a passive investing, S&P 500 tracking fund over the last few years are unlikely to have complaint. They will have enjoyed the momentum which has been seen behind this handful of stocks. For those active fund managers who have varied significantly away from the benchmark, performance is potentially hurting on a relative basis. Concentration undoubtedly means less diversification at the stock level and should those top 10 stocks in the US falter more so than others, those funds with a high active share will enjoy their time in the sun. As always, try to understand fully what you are investing in, and to come back to our fruit juice analogy, make sure no additional sugars and preservatives are added, but more appropriate accompaniments instead.

There are many people who read the above on a bottle of fruit juice and instantly decide it is not for them, the belief being that this version of the natural fruit is not as healthy. This, however, may not actually be the case. So exactly what is it? When the label reads from concentrate it means that most of the water content has been removed through a process of filtration. This retains most of the nutrients from the fruit, leaving a syrup like liquid which is full of natural sugars. If no additional sugars and preservatives are added, however, the reality is there isn’t much difference. So, what relevance is this to investing, you may ask yourself? Concentration within certain investment markets has become a hot topic of conversation and for some a concern. The most frequently discussed is without doubt what we currently see within the US equity market. The dominance in terms of share price return of the ‘Magnificent 7’, being Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta (previously Facebook) and Tesla, means that they represent an ever increasing proportion of US indices, in particular the S&P 500. Such has been the dominance of the returns of these stocks’ relative to others, what is termed as the breadth in the market is extremely narrow. Research from Ned Davis Research shows that in 2024, to the end of June, only 25.15% of companies in the S&P 500 have managed to outperform the return for the S&P 500. Admittedly there is still six months of the year to go, but to place that in some context, the current figure is the lowest seen for each calendar year going back to 1974. This includes the previous low of circa 28% seen in 1998. As a consequence, the correlation of movement between stocks in the S&P 500 is at the lowest level seen for the last 20 years. The negative share price movement of Tesla in the first half of the year meant it dropped out of the top ten constituents. The other six remain, however, and at the end of June the top 10 stocks accounted for a 35.8% weighting. According to data from Goldman Sachs, this compares to a peak of 25% seen during the tech bubble of 1999/2000 and a 35 year long term average of 20%. Whilst this level is undoubtedly high, for some investors it is more than justified given the high level of earnings which they have compared to other stocks within the index. Research from JP Morgan shows that the top 10 stocks account for circa 20% of the overall earnings generated by companies in the S&P 500.

Stock Market Index Concentration

80% 70% 60% 50% 40% 30% 20% 10% 0%

Top 1

Top 10

Swiss - SPI

France - CAC40 Australia - ASX200 Euro Stoxx 50

UK - FTSE 100

US - S&P 500

Source: Swiss SPI stoxx.com, France CAC40 euronext.com, Australia ASX2000 spglobal.com, Euro Stoxx 50 stoxx.com, UK FTSE All Share ftserussell.com, US S&P 500 spglobal.com, FTSE 100 to 31 March 2024.

Lowes Financial Management and Lowes Investment Management are authorised and regulated by the Financial Conduct Authority. Visit: www.Lowes.co.uk | Call: 0191 281 8811 | Email: enquiry@Lowes.co.uk