The illusion of diversification: When seven stocks rule the market
Debate about the so-called “K-shaped economy” — where parts of the economy surge while others stagnate or decline — isn’t just about American consumers anymore. It’s playing out among corporations too, underscoring how much of the stock market’s strength depends on just a handful of companies.
“Since the beginning of the year, profit margins have increased for the Magnificent Seven and declined for everyone else,” wrote Apollo chief economist Torsten Slok in a note describing how this K-shaped pattern has spread to corporate profits.
The data shows that the Magnificent Seven — Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Meta (META), Tesla (TSLA), and Nvidia (NVDA) — have seen profit margins rise roughly 5% to 6% above their January baseline.
In contrast, the remaining 493 companies in the S&P 500 have seen margins fall around 4% before stabilizing slightly in the fall.
Slok’s note highlights a widening profitability gap between mega-cap tech firms and the rest of corporate America.
Earnings growth this year is increasingly concentrated among a small group of companies, reinforcing concerns that the broader market is struggling to keep up outside of the AI-fueled boom.
In this environment, wealth advisers warn that investors may not be as diversified as they think, with the tech sector carrying most of the weight in the S&P 500.
A lack of breadth problem
Charles Schwab investment strategist Liz Ann Sonders and macro strategist Kevin Gordon have again drawn attention to the risks of market concentration, arguing that the dominance of mega-cap stocks is a double-edged sword.
“High concentration can magnify both opportunities and risks,” they wrote in a recent research report, noting that about 54% of ETFs and mutual funds tracking the S&P 500 now use passive strategies.
Passive index funds designed to mirror the index tend to perform well when large-cap tech stocks rally, but they’re far less diversified than many investors realize.
In this environment, “portfolio diversification can [...] be undermined by systemic over-reliance on a handful of dominant companies,” they added.
Michael Reynolds, vice president of investment strategy at Glenmede, echoed those concerns, warning that concentration risk leaves portfolios vulnerable if sentiment shifts.
“When a handful of stocks dominate the market, if you do have a period of disappointment from those stocks, you could see disproportionate impacts on your portfolio from just a handful of company-specific issues,” he told Reuters.
As InvestorsObserver reported, concerns are mounting that the tech-fueled rally could lose steam as investors reassess the true economic and financial impact of artificial intelligence. So far, many AI-linked stocks appear priced for perfection, reflecting expectations that these companies will fully deliver on their lofty promises.