Investors should stop being overly concerned with market concentration risk.

The top 10 stocks, including the Magnificent 7, have hit new highs on the heels of Nvidia's earnings. These stocks now account for about 33% of the S&P 500.

The Magnificent 7 is a popular investment option among registered investment advisors, but their clients are constantly asking them to invest more money in it.

RIAs were concerned about the potential consequences of over-concentration, as they feared that they would be held responsible for any negative outcomes, similar to how they were criticized for not participating in the Mag 7 rally with enough enthusiasm.

The hope of the RIAs was the market rally would broaden out.

Nvidia and the Magnificent 7 experienced a brief lull two weeks ago, but it was just a momentary pause in their relentless march.

The "diversify" crowd's last hope has been dashed by Nvidia's earnings. The numbers clearly show this.

Major Sectors YTD

The Van Eck Semiconductor ETF (SMH) has increased by 20%, with Nvidia contributing to 25% of the growth.

The Roundhill Magnificent 7 ETF (MAGS) has increased by 14%, with Nvidia being the top contributor to this growth.

S&P 500 up 5% (4% Nvidia!)

S&P 500 Equal-Weight ETF (RSP) up 2%

Is over-concentration really a risk?

It appears that the comparisons are becoming excessive.

The Magnificent 7 stocks are now as large as the combined stock markets of Japan, UK, Canada, France, and Hong Kong/China.

Magnificent 7 vs. The World

(MSCI All Country World Index weighting)

Entire U.S. stock market: 63%

Japan, UK, Canada, France, Hong Kong/China combined: 17.5%

Magnificent 7: 17%

Source: Dimensional Funds

It's not unusual to see intense focus like this in previous eras, particularly in the tech industry.

High concentration levels have happened often

According to a 2023 study by FS Investments, the top 10 stocks in the S&P 500 were only 17.8% of the index as late as 2015.

The concentration of the top 10 stocks has been higher most of the time.

In the mid-1960s, the top 10 companies accounted for more than 40% of the S&P 500 index.

In the 1960s and early 1970s, the "Nifty 50" stocks, which included IBM, American Express, General Electric, Polaroid, and Xerox, consistently maintained a dominant position, keeping the concentration of the top 10 stocks above 30%.

Between the 1980s and the late 1990s, the market capitalization of the S&P 500 declined slowly, settling between approximately 17% and 20%.

During the late 1990s, the concentration of the top 10 companies increased to over 25% due to the dotcom and Internet boom.

It’s not just a U.S. issue

The U.S. has a lower concentration of the top 10 names compared to other countries such as China, France, and Germany.

The iShares MSCI China ETF, which is the broadest China ETF, contains over 600 stocks. However, the top 10 stocks, which include Tencent, Alibaba, and Baidu, make up 42% of the entire ETF.

The iShares MSCI Germany ETF has 57% of its weighting in 10 stocks, with 22% in just two stocks, SAP and Siemens.

The iShares MSCI UK ETF has 50% of its top 10 holdings in three stocks: Shell, AstraZeneca, and HSBC.

The iShares MSCI France ETF has 57% of its top 10 holdings in just two companies, LVMH and Total, which make up 20% of the weighting.

The top 10 holdings of the iShares S&P/TSX 60 Index account for 45% of its total value.

Concentration of top 10 stocks in country indexes

China 42%

Germany 57%

UK: 50%

France: 57%

Canada 45%

U.S.: 33%

Concentration has helped U.S. and index investors

Concentration has been beneficial to index investors and U.S. investors as a whole.

The gains in the last year can mainly be attributed to a few tech stocks. Investors who own these stocks don't need to pick the winners; they can simply enjoy the ride.

When a small group of U.S. stocks becomes market leaders, it is almost certain that the U.S. stock market will outperform the world.

The global market capitalization has been taken over by the U.S. stock market, which was previously 40% of the total.

U.S. investors in broadly diversified indexes have been richly rewarded for their "diversification risk."

Sit back and relax a little

Market cap-weighted indexes possess the trait of concentration, which involves rewarding successful companies while penalizing unsuccessful ones.

The success of the Magnificent 7 can be attributed to their status as the world's most profitable companies, which allows them to invest heavily in transformative technologies, particularly AI.

The primary reason they are leaders is because of their efficiency in supply chains, which was facilitated by globalization. Additionally, there were secondary reasons such as the long decline in interest rates, which has now ended.

Despite the challenging growth environment, these companies have experienced significant growth, and investors are willing to pay a premium for their shares.

In the 1990s, the top stocks in the S&P 500 contributed less to the index's earnings and had lower cash flow compared to today.

There’s already been a correction: It was called 2022

The concern among RIAs at the ETF conference was, "What if there's a significant correction in the Magnificent 7?"

Nvidia's stock price dropped by 62% from $292 at the beginning of 2022 to $112 by October, while the other Magnificent 7 stocks also experienced significant declines.

The AI revolution is undeniable.

Nvidia's sales and profits increased significantly, with profits up 800%. This represents a significant revolution in the industry.