The Great Index Fund Transformation: When 7 Stocks Became 31.6% of the Market

Happy Sunday everyone.

Last week, someone asked me why the S&P 500 seems to move in directional lockstep with NVIDIA’s stock price. I told them to imagine a portfolio where every third dollar goes to just seven companies. This is where we are at right now.

When you buy the S&P 500 today that’s exactly what is happening, you’re not getting equal distribution of 500 stocks.

Let’s dig in…

The Magnificent Seven Reality Check

The numbers tell a remarkable story. Today, if you invest $1,000 in an S&P 500 index fund, $316 goes into just seven companies. The Magnificent Seven now control 31.6% of the index—a concentration higher than at the peak of the dot-com bubble.

These seven companies, representing just 1.6% of the index constituents, dominate market movements while the remaining 493 companies split the other 68.4%. This concentration dramatically shaped market returns in 2023.

While the S&P 500 returned 24.8%, the Magnificent Seven delivered extraordinary gains:

• NVIDIA +239%

• Meta +194%

• Tesla +102%

• Amazon +80.9%

• Apple +48.2%

• Microsoft +57%

• Google +58%

The impact is stark: Without these seven stocks, the S&P 500’s return would have been just 13% in 2023—nearly half the actual 24.8% return. These seven companies drove roughly 60% of the index’s total return.

The Hidden Correlation Problem

“I’m diversified,” many folks say. “I own the Nasdaq 100, many sector funds, and the S&P 500.”

Let’s break down what that really means. Imagine a $100,000 portfolio split “safely” across three popular funds:

• $40,000 in SPY (S&P 500)

• $30,000 in QQQ (Nasdaq 100)

• $30,000 in VGT (Technology Sector)

Your actual exposure becomes:

• $12,640 in Magnificent Seven (from SPY)

• $15,000 in Magnificent Seven (from QQQ)

• $15,000 in Magnificent Seven (from VGT)

Total exposure to just seven stocks: $42,640

What feels like a diversified portfolio has accidentally concentrated nearly 43% of your money in just seven companies. This hidden overlap creates a risk multiplier that most investors don’t see.

The Passive Investment Amplifier of Institutional Flow

The sheer scale of passive investing is what makes today different. Let's look at the major players moving markets:

• SPDR (SPY): ~$480+ billion

• BlackRock (IVV): ~$350+ billion

• Vanguard (VOO): ~$330+ billion

• Plus hundreds of smaller institutional funds getting paychecks dripped into them every month

When pension funds, endowments, and institutional managers allocate billions to these index funds each month, it triggers an automatic buying spree. With the Mag7 commanding 31.6% of the index, these funds are forced to funnel nearly a third of every inflow into just seven stocks - regardless of price or fundamentals.

This creates a self-reinforcing loop: As these mega-caps grow larger, passive funds must buy even more of their shares to maintain proper index weighting.

Price becomes almost secondary to the mechanical nature of passive flows.

Historical Warning Signs

The market has seen similar concentration before, each time with sobering lessons for investors:

Market History Lessons:

1970s: The “Nifty Fifty” were considered “one-decision” stocks you could buy and hold forever. Companies like Xerox, Kodak, and Polaroid traded at 100x earnings before their dramatic fall.

These are essentially no-names now.

1999: The tech bubble saw companies like Cisco, Intel, and Microsoft dominate market returns. When the levy broke, the Nasdaq dropped 78% and It would take 15 years for the Nasdaq to regain its peak of March 2000.

At the bubbles peak, tech concentration was 18% of the S&P 500 - far below today’s 31.6%.

2008: Financial stocks made up 17% of the S&P 500 at their peak. When the crisis hit, supposedly “diversified” portfolios fell in sync as sector concentration became a liability. Even giants like AIG and Lehman proved vulnerable.

1989: Japan’s market became dominated by financial and real estate companies, with the top 10 stocks controlling 32% of the market - similar to today’s S&P 500. 

Thirty-five years later, the Nikkei index remained below its peak until just recently this year, a reminder that concentration risk can have generational consequences.

Today's Market Reality

Let's put the market's concentration into perspective:

• Standard S&P 500 (influenced heavily by Mag7): 27.37. Paying
  

• Equal-weight S&P 500 (where each company has same weight): 23.56
  

• Equal Weight vs Cap Weight
  
  - Historically, $RSP (Equal Weight S&P) has outperformed $SPY by 0.98% annually since 2003. But just earlier this yea.. equal weight was lagging by 16% - the worst gap in two decades and a stark divergence from its long-term pattern

We saw some relief in Q3 as market breadth improved, but the structural issue remains: Each month, billions in passive dollars flow into these dominant stocks through index funds, regardless of fundamentals or valuations.

The Index Evolution

Today’s S&P 500 index fund has transformed from its original design and purpose. What was meant to be a tool for broad market exposure has become a tech-focused portfolio.

This write up isn’t about the sustainability of this concentration. The real question is whether investors understand what they now own when buying the S&P: a handful of tech monsters with a side of market exposure.

Stay curious,
- John

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