Since the 2010s, the dynamics of large-cap U.S. equity risks have shifted. Fifteen years ago, the market was dominated by cycles alternating between risk-taking and risk aversion, often referred to as a “risk-on/risk-off” dynamic. A key feature of this period was the higher correlation between stock and sector performance, especially during market downturns.

Exhibit 1 illustrates this trend and what happened since, showing how the average monthly correlation among S&P 500^® stocks has changed over time. Correlation was high relative to history after the 2008 Global Financial Crisis, but it attenuated over the next decade and, although the COVID-19 pandemic and 2022 bear market brought a temporary return, the most recent figures are close to the lowest observed so far this century. Overall, the trend since the early 2010s has been downward, albeit with a few bumps along the way.

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Along with lower correlation in observed stock returns, the options market has also changed to reflect market participants’ expectations for a differing risk environment. Exhibit 2 compares two important indices: the Cboe Volatility Index (VIX^®), which measures expected market volatility, and the Cboe S&P 500 Dispersion Index (DSPX^SM), which measures expected dispersion, or how differently individual stocks in the S&P 500 are anticipated to perform. A higher DSPX suggests that options traders expect more unique stock movements, while a higher VIX indicates a focus on broader market risks. Over the past 10 years, the trend has shown a near-steady increase in expectations for single-stock dispersion, in both absolute and relative terms.

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Just as higher correlation triggered changes in the way market participants managed risks, a decline in correlation and a rise in dispersion may have significant implications. With greater dispersion among stocks, active managers have more chances to outperform the market (but also more opportunities to underperform) through stock selection. Perhaps just as importantly, rather than seeking outperformance by concentrating in one part of the market, it also means there are potentially greater benefits that might be achieved through diversification. Just as a diverse garden with various plants is more resilient to pests and weather changes, a diversified selection of stocks tends to better withstand market volatility. If constituents behave more differently, then their combination is more diversified.

An example of how diversification effects may be strengthening is illustrated by another important way in which U.S. equity markets have evolved. The recent rise of the very largest of U.S. names has been much remarked upon (here and elsewhere). In concrete terms, the weight of the largest 10 companies in the S&P 500 more than doubled over a 10-year period, from 17.9% at the end of 2014 to 37.7% at the end of 2024. All else being equal, we might expect a higher correlation nowadays between the performance of those top 10 names and the benchmark S&P 500.

However, as illustrated in Exhibit 3, the fact that the other 490 companies’ stocks are behaving more differently means that, despite their rising weights, the correlation between the 10 largest stocks and the benchmark has not materially changed.  For reference, Exhibit 3 also shows the weight of the S&P 500 Top 10 Index constituents within the S&P 500, and the correlation between the S&P 500 Top 10 Index and a capitalization-weighted combination of the remaining 490 companies.

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So, what does it all mean? On one hand, concerns about the concentration of U.S. equities may be exaggerated; the largest stocks haven’t dominated market behavior any more than usual. On the other hand, the widening performance gaps among S&P 500 stocks underscore the potential for more nuanced strategies as well as the potential advantages of diversification. As the risk landscape continues to shift, liquid, index-based tools could empower investors to adapt with it.

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