According to JP Morgan’s Guide to the Markets 3Q26, an S&P 500 index fund has been one of the best places for equity investment money since the fiscal crisis. The S&P 500 is an unmanaged index of 500 widely held stocks generally considered representative of the US stock market and few portfolios with a similar investment objective have performed better over this timeframe. What happens, though, when 2% of the companies in the index become 40% of the index capitalization over time?
The 10 largest companies in the S&P 500 represent nearly 40% of the overall index. This is a level of index concentration not seen since the mid-1960s. This current imbalance has been driven by technology and the artificial intelligence (AI) revolution. This isn’t an argument against owning the companies dominating the current era. There are compelling reasons to own them. However, at today’s valuations, the passive strategies following them are increasingly dependent on a singular path forward. History doesn’t usually reward myopia.
In 1980, fossil fuel companies represented nearly a third of the S&P 500. Today, they are roughly 3% of the index. At the peak of Japan’s equity boom in the late 1980s, Japan became nearly half of the MSCI World Index. Today, it’s about 5%. The past rarely repeats itself… but it can rhyme. These earlier periods are reminders of what the future may hold for today’s market leaders.
The S&P 500 first reached 100 in the late Summer of 1968. It didn’t return to that level to stay until the Summer of 1979. This represents a lost decade for a passive investor participating in a strategy to match the index. A similar pattern occurred when the S&P 500 first reached 1,000 in the Spring of 1998. It wouldn’t return to that level to stay until late Summer of 2009. In both of these “lost decades” many actively managed portfolios thrived while the passive index languished.
The cause of stagnation on the index during these times of pause is the unraveling of the concentrated positions. While the rest of the index carried on with business as usual, money that had appreciated in the largest holdings moved to other companies in other areas of the economy.
The goal of any investment is projected future values. Money will flow from areas that have appreciated to areas that are expected to appreciate. When the money is flowing away from highly concentrated positions in the index, overall index valuations may suffer while other companies in the index are thriving.
The current concentration in the indices is driven by the same myopic vision that dominated prior periods—a belief that current conditions will continue indefinitely. History tends to tell a different story.
The markets of the late 1990s were driven by the build out of the internet. The trade unraveled when the anticipated return on investment wasn’t realized. Even though the internet has become the backbone of the world economy, most users seek free tools and entertainment while a minority invest in more expensive solutions.
The AI revolution may follow a similar pattern. Where the internet has given us the ability to argue with strangers and watch videos of cats, AI allows users to argue with bots and make their own videos of cats. Currently, most users use AI for cheap entertainment and efficiency while a minority of power users pay the bills. If that doesn’t provide a significant return on the investment, money may flow to more promising areas.
Times of market concentration are a time to put aside recency biases and look to the future. It can be a challenging time for investors to be passive in their investment approach.
