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Tom Limoges

May 02 , 2016

A Look At Market Concentration Risk


Over the last two weeks, several technology bellwether stocks announced disappointing quarterly earnings reports. This news not only negatively impacted the stock price of the individual company and technology sector, but also the overall U.S. stock market. Why would the results from a handful of stocks have an impact on a market index such as the S&P 500; which is widely believed to be broad based in nature?

First, given the size of the companies that reported earnings (Apple, Microsoft, and Alphabet/Google), it is viewed that the slowdown in earnings and revenue growth affect not only the reporting company, but the companies they do business with. They also affect the competitors as well. For instance, a slowdown in iPhone sales affects Apple, but also Qualcomm and Intel who supply chipsets to Apple to manufacture the iPhone. Other competing smart phone manufactures would likely see their shares fall as result of the shortfall.

Second, those three companies mentioned above have a large representation in the overall cap-weighted S&P 500 Market Index. A capitalization (cap) weighted index is a type of market index whose individual components are weighted according to the size of the company. The larger the company is, the larger the representation in the index. Earlier this year, the combined weighting of Apple, Microsoft and Google was over 8% of the index. Because the index is cap weighted, there is a higher concentration of the index in these companies. At the end of 2015, nearly half of the index weighting was concentrated in the top ten percent of companies that made up that index.

Diversification is a key component to the process we follow in developing portfolios for our clients. In order to produce the best long term risk adjusted rate of return, we believe in blending a variety of different investment management styles to avoid being concentrated in single stocks. If you would like us to review any outside investments for concentration risk, please contact your investment advisor to set up an appointment.


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