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Published On: February 25, 2025

Written by: Ben Atwater and Matt Malick

Although the market is performing fairly well to begin 2025, we still believe there are some underlying misalignments in today’s stock market. Of course, market timing is impossible, so we are looking instead to continue to manage risk while remaining active stock market investors.

Earlier this month, we looked at potentially excessive valuations through the lens of the ratio of market capitalization to gross domestic product, a favorite indicator of Warren Buffett who said that when this ratio hits 200%, where it currently is, you are “playing with fire.”

Then we turned our attention to the extreme concentration among the largest stocks in the S&P 500, pointing out that today the eight largest companies in the S&P 500 make up 33% of the capitalization-weighted stock index, an unprecedented concentration of leadership.

Now we turn our attention to a related phenomenon and that is narrow market leadership, which means that only a small percentage of stocks are outperforming the overall index. The chart below from Richard Bernstein Advisors nicely illustrates this anomaly.

With 30% or less of all stocks outperforming the overall index in 2023 and 2024, we have witnessed the smallest percentage since the last major tech bubble in 1998 and 1999. Before that you must look back to the Nifty Fifty stock bubble of the 1970s to see such skimpy leadership.

In the late 60s and early 70s, investors adored a group of blue-chip stocks, which commentators nicknamed the “Nifty Fifty.” Unlike the Dot-com bubble (late 1990s) or the Pandemic bubble (2021) which unprofitable companies’ (meme stocks) fueled, the Nifty Fifty were highly profitable but became overvalued.

We could make the same argument about today’s market leadership. However, nobody really knows how concentrated is too concentrated or how overvalued is too overvalued. Trends can persist for years and years.

A November 2024 Goldman Sachs piece entitled “Top of Mind – Market Concentration: How Big a Worry?” argued that market volatility tends to significantly increase during the year after extremely narrow markets.

With narrow leadership and higher valuations, we expect more volatility this year.

We continue to believe that the prudent avenue for investors is to remain – and even to increase – diversification. We think this will serve us well whenever this cycle wraps up and a new cycle emerges.