EC Concentration Risk Reaching Historic Levels

Earlier this month, long-time broadcaster Hugh Downs died at the ripe old age of 99 (Full disclosure: I worked with Hugh during his tenure as a PBS host in the early ‘80s). Among his many network gigs was an 11-year stint as host of the game show “Concentration,” which challenged contests to recall the placement of prize tiles to solve a puzzle.

There’s another version of concentration that often confronts investors, one that sometimes offers prizes and at other times aggravated losses. A portfolio is deemed concentrated when an inordinate exposure to an individual stock, sector or style is countenanced. Sadly, there’s no hard-and-fast definition of inordinate exposure but, like Supreme Court Justice Potter’s description of pornography, you’re likely to know it when you see it. That is IF you can see it.

Often, concentration is implied through its opposite number—breadth. While measures of market breadth abound, there’s one simple-to-follow metric that sheds light on the concentration found in that most ubiquitous of benchmarks, the S&P 500 portfolio.

By taking the price ratio of the Invesco S&P 500 Equal Weight ETF (NYSE Arca: RSP) over the SPDR S&P 500 Trust (NYSE Arca: SPY), you can actually see concentration in action. RSP, as its name implies, takes all the S&P stocks and weights them equally. SPY, like the index it tracks, weights its stock holdings by their market capitalizations.

Cap weighting allows portfolio positions to rise and fall as share prices and floats vary. As investor interest in Inc. mushroomed, for example, so too did its heft in SPY. Five years ago, AMZN was a $400 stock. Now it changes hands at nearly $1,600 a copy and accounts for nearly 5% of SPY’s total capitalization. At the opposite extreme is lowly Coty Inc., claiming just a half-percent of the ETF’s market value. The upshot? As AMZN goes, so goes SPY. COTY’s influence on SPY’s market direction is negligible.

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Disclosure: None.

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Moon Kil Woong 1 year ago Contributor's comment

Amazon isn't the problem. It's the other FAANG stocks. Adding Tesla to the S&P 500 just further highlights the high PEs and ridiculous market caps of many of these stocks. Microsoft and Google should get heir own acronym for big decently priced companies and let the rest of the FAANGs go down alone.

Harry Goldstein 1 year ago Member's comment

The bears should go short $LB instead. I've been selling short everyday and buying back on dips. Lots of money to be made.