The stock market is relying less on a handful of stocks to do its heavy lifting
But the biggest companies' contribution to earnings and sales growth - the most important drivers of the bull market - has been falling since 2010, Morgan Stanley found. Instead, earnings growth is becoming spread out among more stocks.
The implication of lower concentrations for earnings and earnings growth is positive for investors: one big company's miss is less likely to send a shockwave through the rest of the market.
"Fewer stocks are doing the heavy lifting as more stocks have meaningful contributions to these metrics," wrote Brian Hayes, the head of equity quantitative research, in a note Thursday. "This is positive from a risk perspective; the market is becoming less dependent on a small group of stocks to drive earnings and revenue growth numbers."
Large tech and bank stocks have made the largest percent contribution to positive earnings over the last five years. Hayes forecasts that Micron Technology, Apple, and Chevron would add the most this year. Hayes expects Apple to be the biggest contributor to S&P 500 earnings growth in 2018, adding 7.6%. But that would be down from 9.1% in 2015.
Earnings-growth concentration is falling as investors sell shares of companies that miss on earnings and revenue more aggressively than they buy shares of companies that beat. In other words, the risks are high for individual companies, but lower for the overall market.
The earnings slowdown that mostly hit energy and material stocks in 2015 marked a turning point for growth concentration, Hayes said. That's because earnings growth tends to become more concentrated as the number of stocks contributing to positive earnings declines. Hayes' analysis only included companies with positive earnings growth.
Lower earnings concentration doesn't eliminate the short-term risk that investors who have crowded a well-performing sector like tech are vulnerable to steep losses when the direction turns. Tech's overweight in actively managed fund holdings, at 25%, is at a record high today, up from just 5% three years ago, according to Bank of America Merrill Lynch. In fact, Hayes noted that the more common question from investors is whether returns, not earnings growth, have become too concentrated in one sector.