Research & Insight

The strong performance of large-cap stocks over the past decade has left the market exceptionally top-heavy. By some measures, stock market capitalization has never been more concentrated among a handful of large stocks as today. Following periods of high market concentration, stock market returns are not only low over the subsequent decade, on average, they also tend to be highly volatile. Taken together, these characteristics – losses for Mega-Cap stocks, strong relative returns but low absolute returns for Non-Mega Cap stocks, and lots of market volatility – offer a potentially overlooked benefit for long-term investors choosing how to structure their portfolios.

The heady optimism in forecasted earnings is hiding in aggressive expectations for profit margins. The rise in market valuations has been much more tightly linked to those elevated margins - and expectations for even higher margins next year and the year after - than investors may realize. If the widely held belief that public companies will perpetually become more profitable begins to falter, the steep valuation premium that has been priced into U.S. large-cap stocks over the past decade may evaporate.

The primary drivers of major stock market declines - extended valuations, a sharp rise in interest rates, and growing recession risks - are rarely as elevated, in combination, as they are today. Even a “small r” recession could lead to a deep stock market decline, and the bulk of those losses could occur before the recession is even recognized.