Heading into the final weeks of 2021, an important trend has emerged in the stock market: The hyper-concentration of returns that saw a handful of stocks responsible for much of the gains last year has faded.
Some of the largest stocks in the market still dominate returns to a degree that's greater than in previous years. Case in point is Tesla (TSLA), whose wild swings can shave returns off funds that track broad US market indexes, thanks to its current status as the fourth-largest stock.
During 2020, the concentration of stock market returns reached a peak amid the pandemic-induced volatility. But the trend in 2021 has shifted toward a lesser degree of concentration of returns. For investors, this is a potentially healthier dynamic, with less risk for index-tracking funds and more opportunities for stock-pickers.
Last year, the five largest stocks--Apple (AAPL), Microsoft (MSFT), Amazon.com (AMZN), Meta Platforms (FB), and Tesla--contributed a massive 37% of the market's returns. In contrast, this year through late November, the five largest stocks--the same group with the exception of Alphabet (GOOG) taking the place of Meta--contributed just 8% of market returns. That compares with an average of 3% from 2009 through 2019.
The actual FAANG stocks--Facebook (now Meta), Apple, Amazon, Netflix (NFLX), and Google (now Alphabet)--have contributed 2.7% of returns in 2021, down from 24% in 2020.
"The unwinding of concentration is good for investors and the health of the market," says Dan Kemp, global chief investment officer at Morningstar Investment Management. "Concentrated portfolios tend to be less robust to a change in the economic environment and have further to fall in the event of unexpected headwinds due their lofty valuations."
It's natural for there to be clusters of outperformance or underperformance in the markets. And when one of those clusters involves the largest stocks, that can have a significant impact because the largest companies make up the largest weights of the benchmarks that are most widely tracked by index funds.
To measure just how concentrated stock returns have been, we calculated the impact that the 10 largest stocks have had on the Morningstar US Large-Mid Index, which essentially tracks 90% of the stock market. We took the 10 largest stocks at the end of each year going back to 2009, and using Morningstar Direct's equity attribution tool, excluded their returns from the index's performance and compared that number with each year's total return.
In the following table, the concentration of returns can be seen across the readings for the largest stocks. For example, the three largest stocks accounted for less than 10% of returns in most years since 2009, and often just in the very low single digits. But in 2020, the three largest stocks were responsible for 27% of the market's returns. That figure dropped to 2% this year.
One quirk is that when the market has only a small move, such as 2015's 0.92% change, or is basically flat as it was in 2011, the results can be distorted. It's a similar story for the math in 2018, when the market was down but each of the 10 largest stocks rose. So, to create a more useful comparison point, we're excluding those three years from our long-term average.
Overall, the picture for 2021 marks a meaningful change from 2020's dynamic and is closer to the long-term picture.
Drilling down into the underlying stocks shows the roots of the change. In 2020, Apple, with the top weighting in the index at 6.12%, rose 81.84%. At such a high weighing in the index, that meant Apple alone--out of 699 stocks in the Morningstar US Large-Mid Index--contributed 13% of the year's 20.9% gain. Add in Microsoft and Amazon, and more than one fourth of the year's return was accounted for by just those three stocks.
This year, the concentration is less pronounced, even though the top five stocks are still providing above-average contributions to market returns. Microsoft, 2021's largest company with a market weighting of 5.75%, by itself contributed 9% of the market's 25.5% return as of Nov. 19. Apple, the next-largest stock in the index, returned 21.7%--a 4% contribution to the market's total. The third-largest stock, Amazon, returned 12.9%--contributing just 2% of the total.
"This year has been a mild-mannered correction to the extremes of 2020," says Russ Kinnel, director of manager research at Morningstar. "With a recovery and surprising economic growth and low unemployment, 2021 has been a great environment for value and everything that was dumped due to COVID."
On the flip side, Kinnel says, these trends took some oxygen away from the FAANGs and other work-from-home stocks, but it was largely a correction via underperformance.
Over most of the past decade, the proportion of market returns coming from the largest companies has steadily increased. In 2017, the largest five stocks contributed 9% of market's total returns, up from just 6% in 2016. And in 2019, the top 10 holdings contributed 10% of the market's annual return of 31%.
Market concentration came to a peak in 2020 when the top five holdings alone contributed nearly 40% of the market's return for the year. This year, the largest five stocks have been responsible for 8% of market return, while the largest 10 stocks contributed a total of 20%.
Kinnel says that it's premature to call the FAANG market dead, but the year's relative cooldown of the largest stocks does show the market is behaving in a fairly rational way, "even though meme stocks and crypto tell us there's still a lot of irrational behaviour going on."
