Concentration and the rise and fall of large companies
Hedge fund Bridgewater Associates recently investigated the largest US stocks in history. Morningstar's James Gruber looked at lessons for investors.
Much has been made of the concentration of the US stock market. Rightly so, given the 10 largest US companies account for almost one-third of the US equities market capitalization – the highest percentage in decades.
In a recent report, hedge fund Bridgewater Associates investigated the largest US stocks through history, how long they stayed at the top, and what led to their downfalls. They were interested in what lessons could be taken from the past and applied today.
The chart below shows the rise and fall of large companies by market cap across different decades.
The chart confirms that the concentration of the top 10 US companies is high versus the past. And that the drop-off of stocks after peaking is normally steep through history.
Staying on top is difficult
Not every era is the same. Some stock titans stay on top for decades, while others decline sharply. As a rule, though, most succumb to increasing competition and the forces of creative destruction.
As to how leading US stocks, or ‘market champions’ as Bridgewater calls them, have performed compared to the market, the news isn’t reassuring either:
“Over a subsequent decade or two, about half of the market champions underperform the market and fall out of the top 15 champions group. And over long periods of time, almost all champions are dethroned.”
Bridgewater suggests there’s a lifecycle to companies. The ones that turn into megacaps tend to have “first-move advantage in a high secular growth industry benefiting from rapid innovation.” These companies have an edge or moat that allows them to keep competitors at bay for a time. However, the same forces that propel their rise also lead to their downfall. Eventually, newer, faster companies take their place and gain market share.
The businesses which can stay on top normally continue to innovate and they may also receive favourable regulation along the way, keeping competitors at bay.
Stock market titans through the decades
From 1900 to 1920, railway stocks dominated the US market. Railways were central to US industrialisation, starting in the second half of the 19th century. They were the only reliable means of transporting goods across the country.
Companies competed fiercely as the railway system expanded. But by 1900, the industry had consolidated, with the formation of powerful railway monopolies. Railway companies accounted for five of the top 10 stocks by total US market cap in 1900, and that increased to six out of 10 by 1910. At their peak, railroads were more than 30% of the US market cap.
But in the 1920s, new competition came principally from trucks (airplanes less so at that stage). Trucks were helped by less regulation on pricing and route-setting compared to rail.
From 1920 to 1940, different market leaders emerged. Oil giants moved to the top, while new companies rose, such as AT&T, the leader in building out US telephone networks. Chemicals company, DuPont, became a megacap, riding advances in materials such as the invention of nylon and Teflon. And GE emerged as a giant, first as a television broadcaster, then as an aircraft supplier.
Many of these companies stayed on top for decades. Post World War Two and the rise of consumerism, retailers like Sears also entered the top 10 market stocks.
In the 60s, chemicals companies lost their stock market dominance as the economy shifted away from manufactured goods to services, and research linked them to health issues, damaging their reputations. Auto companies like Ford and GM remained dominant in the 60s, though that started to fade in the 70s due to greater competition and slowing demand. Tech businesses such as IBM, Xerox, and Eastman Kodak started their ascent in the 1960s.
By 1980, oil stocks were back on top, thanks to an inflationary decade that saw oil prices soar. Six of the top 10 stocks were in the oil industry by then. High inflation impacted consumer demand for many companies, from retailers like Sears to the automakers.
The 1990s witnessed a very different decade as inflation growth subsided. Oil companies lost their dominance. Pharmaceutical companies including Merck and Bristol-Myers entered the top 10 stocks, with the discovery of blockbuster drugs like Merck’s hepatitis B vaccine.
By 2000, tech was ascendant, with five businesses (Microsoft, Cisco, Intel, IBM, and Lucent) in the leading 10 stocks by market cap. Walmart made its first appearance as a megacap. Meantime, Citigroup, following the merger of Citicorp and Travelers Group, became the first bank to make the list since 1930.
By 2010, the tech bubble had burst, and the world was still recovering from the worst financial crisis since the Depression. More defensive companies (Berkshire, Walmart, Procter & Gamble, and Johnson & Johnson) made it into the top 10 stocks. GE started to slip as acquisitions from a prior CEO Jack Welch turned awry. Telecom companies like AT&T declined due to the fading relevance of landlines over cellular networks, anti-trust regulation removing longstanding barriers to entry, and the rise of new cellular and internet-focused players.
The 2020s have been dominated by the IT companies, with incredible growth from social media, smartphones, and software. The leading five stocks were all tech firms.
Global portfolios hold more US megacaps than ever
The current concentration of the US market has implications for Australian investors too. The leading 10 stocks in the US not only make up almost one-third of the US total market cap but they also account for close to 20% of the global total market cap – the highest in more than 50 years. In other words, anyone investing overseas is likely to have high exposure to these stocks.