Mega-cap stocks like Apple and Microsoft have proved remarkably resilient since the coronavirus outbreak – a phenomenon that may be cause for concern.
So says Morgan Stanley, which cautions that it's typical of bear market rallies for high-quality, large-cap companies with the ability to grow earnings in poor economic conditions to lead the rebound. The fact it's happening now is therefore "nothing to cheer about".
Overall market conditions aside, the bank suggests three reasons why investors should consider scaling back on large-cap winners.
Firstly, concentration risk is rising. Although the five largest stocks (Microsoft, Apple, Amazon, Google and Facebook) account for only 7 per cent of S&P 500 profits, they account for 21.4 per cent of the index – the highest level since 1978. The same five stocks account for 44 per cent of the Nasdaq index, a record.
Crowding
Both stats suggest investors “may be a lot less diversified than they think they are”.
The second risk is crowding, when hedge funds and institutional investors pile into the same companies. If conditions change and everyone heads for the exits at the same time, high-quality stocks “can fall much faster than you might expect”.
Thirdly, there is the question of valuation. The top five stocks trade on 50 times estimated profits, compared to an average price-earnings ratio of 17 for the index’s other 495 constituents. Today’s leaders, the bank cautions, “could quickly become laggards”.
