Equity market concentration is near record as Apple hits $3trn in value

Market concentration has eclipsed the 1977 peak

The outperformance of mega caps has led to a discussion of market concentration and the proper way to define it is the Herfindahl-Hirschman Index which is essentially the sum of squared index weights. Judged on this metric the S&P 500 hit peak market concentration back in August 2020 and declined until May 2021 before rising at a rapid pace again. As of 13 December the S&P 500 is close to record high market concentration using data since 1991 on S&P 500 index weights. We are not sure it will necessarily prove a turn in equities but rather the end of the mega cap trade. If inflation continues at a high level in 2022 the HHI of S&P 500 could increase further before peaking, but nevertheless, we are getting closer to a point where mega caps will stop outperforming simply because they become too big and will be exposed to competitive and regulatory forces.

Back in March 2018, the MSCI Inc. (the company behind the famous MSCI equity indices) published an article saying that the five largest US companies on market value had still not eclipsed the peak in 1977 where IBM was the biggest stock with a market weight of little more than 5%; today’s market weight of Apple is 7% and Microsoft is 6.4%. In 1977, the top five companies peaked just below 18% combined market weight. In today’s equity market the top five market weight peaked in August 2020 at 22.3% and is 21.6 as of 13 December. In other words, we live in an extremely concentrated world of business and we probably have to go back to the trust days of Standard Oil to find anything similar.

Apple flirts with $3trn market value

Apple's $3trn market value is an extraordinary journey of a technology company that is changing its mix from hardware towards more on services and subscriptions which come with a higher operating margin. It has been the trajectory for years and has lifted the EBITDA margin from 30.7% in FY18 to 32.9% in FY21 which has improved free cash flow generation as capital expenditures have not increased meaningfully.

In those three years the valuation on EV/Sales has gone from 3.6x to 7.9x reflecting the market's increasing confidence that Apple will be able to defend its market share on hardware and grow the business by selling content, services, and subscriptions on that unit base. The robustness of the business and its upward operating margin trajectory coupled with ever lower negative real rates are increasing its market value. It is all justified for now, but if either interest rates go up by 100 basis points or the company cannot lift its operating margin, then suddenly we could see a significant in Apple’s equity valuation. But Apple is part of the mega caps vs everything else in which investors are preferring mega caps due to their predictability on cash flows and their market power providing them with the ability to pass on rising costs from inflation.