Big Tech and the S&P 500: Look beneath the surface

We argue that three complementary indicators point to increasing concentration in the S&P 500 market rally: 

1) A five-year-long outperformance of the (capitalization-weighted) S&P 500 relative to the equally-weighted S&P 500;

2) A six-month-long divergence between the (capitalization-weighted) S&P 500 and the ratio of rising-to-falling stocks; and

3) A fall in entropy, a better metrics of concentration within the S&P 500, shows that the current degree of concentration, which is largely attributable to Big Tech, is historically high. 

This increasing concentration hints at growing imbalances in the economy. 

After a period of modest outperformance from April 2015 to March 2020, the capitalization-weighted S&P 500 has been trading sideways relative to its equally-weighted clone ever since 23 March 2020. This over-performance indicates that the largest stocks by market capitalization have outperformed the rest of the market during this period.  

Commonly used stock market indices are market capitalization-weighted averages. Such is the case, for example, of the S&P 500 index: the larger the market capitalization of a given constituent stock (number of outstanding shares times share price), the larger its weight.  To convince oneself about this, one just needs to compare the annualized rate of return of the S&P 500 with that of its equally weighted clone between selected turning points, as shown in Figure 1. In bull as well as in bear markets, the capitalization-weighted S&P 500 has sometimes outperformed, sometimes under­per­formed the equally weighted S&P 500, most of the time by a large margin. The over-performance of the capitalization-weighted S&P 500 between 24 February and 23 March 2020 confirms the shift to more concentrated gains in a few large-cap stocks (as seen during the dotcom bubble between March 1994 and March 2000 or again between April 2015 and March 2020).

A second measure of concentration is the number of stocks that rise or fall during each trading day, the assumption being that the larger the number of rising stocks, the healthier is the market rally, for the more balanced is growth. Zooming in on the most recent period shows that the smoothed rises-to-fall ratio reached a peak on 17 January 2020.  

Unfortunately, the number of rising or falling stocks varies a lot from one day to the next (as well as the number of shares that remain unchanged). Therefore, to extract a signal from the noise, one needs to smooth he daily rises-to-falls ratio by means of an exponential average.

While the rally that started on 23 March has pushed the capitalization-weighted S&P 500 to new highs, the rises-to-falls ratio has failed to reach a new high. This second divergence indicates that the rally triggered by the U.S. Federal Reserve’s intervention has been a concentrated one, too. One can also observe that, at its current level of 52.44, the ratio of rises-to-falls still lies close to the upper limit of its historical range of fluctuations, that is, well above the troughs experienced in 2002 and 2008, or even in 2015.



Eric Barthalon
Allianz SE