The traditionally defensive US equity market is looking like a much riskier bet these days. Photo: AFP
Patrik Schowitz
Patrik Schowitz

Volatile tech stocks expose growing vulnerability in US market

  • The domination of a few tech giants means the US stock market is more vulnerable to both narrow bull runs and sharp reversals in investor sentiment
  • In Hong Kong, the trend of Chinese companies listing in the city is making the market more diversified as it becomes more closely linked to the mainland economy
After surging through the summer, technology stocks have recently unnerved investors by starting to bounce around. This has put a spotlight on just now narrowly concentrated the US stock market is on a handful of large companies.
This is actually fairly common in smaller equity markets dominated by a small number of national champions. Taiwan and South Korea are good examples, with TSMC accounting for nearly a third of the Taiwan Stock Exchange index and Samsung Electronics for over 20 per cent of the Korea Exchange index. Even in the MSCI emerging market equity index, the 10 largest stocks account for nearly a third of the total value.

The problem with this is not hard to see: it can leave a national or regional equity market vulnerable to bad news concerning just a few companies or one sector in the economy, like a farmer who has only planted one type of crop and risks financial ruin at harvest time if that particular crop is wiped out. The opposite can also apply, of course. When that dominant company or sector does well, it lifts the overall market.

This issue might be less concerning for smaller markets since investors can diversify their risk by spreading their money across a range of markets or, indeed, do the opposite and invest across single companies to reflect their views and preferences.

The latest Apple store in Singapore. Apple is one of the five tech giants dominating the S&P 500 index. Photo: @marinabaysands/Instagram

However, it is a different story when a tiny club of powerhouse companies dominate the run-up in the largest equity market in the world. With a value of around US$30 trillion, the US accounts for nearly 60 per cent of the global equity market universe and is seen both as a barometer for the health of the global economy and as representing a huge share of global savings.

The narrow bull market has been almost entirely driven by the huge success of just a small number of so-called mega-cap technology stocks. Before the latest volatility, the top five largest stocks in the US benchmark S&P 500 index accounted for around a quarter of its total value. Reflecting just how rich valuations had become, their share prices had risen by over 50 per cent in the first eight months of the year, while the overall market had gained just 11 per cent.

Without taking a view on whether these share price gains were justified by long-term business fundamentals, this had left the US market heavily exposed to any change in investors’ bullish view on these stocks.

The French headquarters of Microsoft in Paris. Microsoft is another tech giant dominating the S&P 500 index. Photo: AFP
And while today’s US tech champions have successful and highly profitable business models – many even increasing their profits through the Covid-19 crisis – the extreme investor crowding has stoked prices to eye-watering valuations, leaving them vulnerable to swings in potentially overheated investor sentiment.

All in all, these developments have made the traditionally defensive US equity market look like a much riskier bet, prone to bouts of upward momentum that could be in danger of reversing sharply.

To be sure, this is not the first time that concentration has become an issue in the US market. There is the relatively recent tech bubble in the late 1990s and, going back further to the early 1970s, the domination of the “Nifty 50”. However, the current degree of concentration exceeds both of these episodes. And, perhaps ominously, neither of them lasted.

Beware: the US-China technology war is about to burst the tech bubble

Regardless of how the recent volatility plays out, the ever-changing make-up of markets, which reflects the evolving nature of economies, needs to be better observed and understood. This does not always have to be worrying news.

Here in Hong Kong, the make-up of the local market is arguably becoming more attractive to global investors. Long dominated by the financial sector, the recently accelerating trend of Chinese companies listing in Hong Kong is actually making the market more diversified in its sector exposure, even as it becomes more closely linked to the mainland’s economy.

Patrik Schowitz is a global multi-asset strategist at JP Morgan Asset Management