Head of Equity Strategy
Summary: Mega caps have outperformed almost everything this year sparking talks about an unhealthy equity market lacking breadth and potentially peaking. The US equity market peaked in terms of concentration in August 2020, but mega caps have recently outperformed a lot pushing the market concentration close to record highs. Apple has led the increase hitting potentially $3trn market value in today's session. The US equity market concentration has eclipsed the previous record from 1977 and the days of Standard Oil are likely the only comparison left for this market.
Mega caps in high demand due to growth and stability
Our Mega Caps theme basket which consists of the 25 largest companies in the world representing $19.7trn in market value is the third best performing basket this year up 37%. In the past two months alone the basket has outperformed the MSCI World Index by 12.5% catapulting mega caps and the lack of breadth into recent market discussions with some market commentators saying it indicates a potential top in the equity market. Judging from history only the dot-com peak in market concentration marked a top, whereas the market concentration peak in 1977 did market a meaningful pivot point or market top.
For most of the year in presentations we have argued that investors should overweight mega caps as these companies can better transmit inflation to their customers due to market power. With rising inflationary outlook and ever more negative real rates investors are betting on sure things in equities and mega caps provide both high revenue growth (20% over the past year) and incredible stability in operating margins. Analysts remain positive on mega caps with price targets 13% above current prices.
| Name | Industry | Market Cap (USD mn.) | Sales growth (%) | EPS growth (%) | Diff to PT (%) |
| Apple Inc | Technology Hardware | 2,944,128 | 33.3 | 72.0 | -4.4 |
| Microsoft Corp | Software | 2,571,784 | 19.8 | 32.7 | 6.4 |
| Amazon.com Inc | E-Commerce Discretionary | 1,746,738 | 31.6 | 49.7 | 19.5 |
| Alphabet Inc | Internet Media & Services | 1,969,346 | 39.3 | 85.3 | 13.3 |
| Meta Platforms Inc | Internet Media & Services | 917,285 | 42.2 | 59.6 | 21.3 |
| Tencent Holdings Ltd | Internet Media & Services | 574,534 | 21.0 | -6.0 | 30.9 |
| Alibaba Group Holding Ltd | E-Commerce Discretionary | 339,027 | 39.4 | 17.8 | 62.4 |
| Tesla Inc | Automotive | 1,021,367 | 66.3 | 392.2 | -17.5 |
| Taiwan Semiconductor Manufacturing Co Ltd | Semiconductors | 617,817 | 16.7 | 17.5 | 14.0 |
| Berkshire Hathaway Inc | Insurance | 645,374 | 23.9 | 25.2 | 13.8 |
| Visa Inc | Technology Services | 464,792 | 10.3 | -5.4 | 28.7 |
| JPMorgan Chase & Co | Banking | 472,311 | -4.7 | 101.3 | 12.0 |
| Samsung Electronics Co Ltd | Technology Hardware | 388,275 | 12.5 | 40.2 | 16.4 |
| Johnson & Johnson | Biotech & Pharma | 435,668 | 13.1 | 18.5 | 12.7 |
| Kweichow Moutai Co Ltd | Beverages | 418,062 | 11.1 | 12.6 | 4.7 |
| Walmart Inc | Retail - Consumer Staples | 391,200 | 4.2 | 16.7 | 19.2 |
| Mastercard Inc | Technology Services | 343,816 | 14.1 | 14.2 | 23.1 |
| Walt Disney Co/The | Entertainment Content | 277,574 | 3.1 | 35.2 | 27.2 |
| UnitedHealth Group Inc | Health Care Facilities & Svcs | 450,422 | 10.6 | -7.4 | 0.8 |
| LVMH Moet Hennessy Louis Vuitton SE | Apparel & Textile Products | 406,300 | 16.9 | 101.7 | 5.4 |
| Bank of America Corp | Banking | 364,355 | -7.7 | 59.4 | 10.8 |
| Procter & Gamble Co/The | Household Products | 376,205 | 6.4 | 6.1 | -2.8 |
| Nestle SA | Food | 381,059 | -3.7 | 5.6 | 1.5 |
| NVIDIA Corp | Semiconductors | 754,950 | 64.3 | 87.1 | 14.6 |
| Home Depot Inc/The | Retail - Discretionary | 433,777 | 17.6 | 30.1 | -2.5 |
| Aggregate / mean | 19,706,166 | 20.1 | 50.5 | 13.3 |
Market concentration has eclipsed the 1977 peak
The outperformance of mega caps has led to a discussion of market concentration and the proper way to define it is the Herfindahl-Hirschman Index which is essentially the sum of squared index weights. Judged on this metric the S&P 500 hit peak market concentration back in August 2020 and declined until May 2021 before rising at a rapid pace again. As of 13 December the S&P 500 is close to record high market concentration using data since 1991 on S&P 500 index weights. We are not sure it will necessarily prove a turn in equities but rather the end of the mega cap trade. If inflation continues at a high level in 2022 the HHI of S&P 500 could increase further before peaking, but nevertheless, we are getting closer to a point where mega caps will stop outperforming simply because they become too big and will be exposed to competitive and regulatory forces.
Back in March 2018, the MSCI Inc. (the company behind the famous MSCI equity indices) published an article saying that the five largest US companies on market value had still not eclipsed the peak in 1977 where IBM was the biggest stock with a market weight of little more than 5%; today’s market weight of Apple is 7% and Microsoft is 6.4%. In 1977, the top five companies peaked just below 18% combined market weight. In today’s equity market the top five market weight peaked in August 2020 at 22.3% and is 21.6 as of 13 December. In other words, we live in an extremely concentrated world of business and we probably have to go back to the trust days of Standard Oil to find anything similar.
Apple flirts with $3trn market value
Apple's $3trn market value is an extraordinary journey of a technology company that is changing its mix from hardware towards more on services and subscriptions which come with a higher operating margin. It has been the trajectory for years and has lifted the EBITDA margin from 30.7% in FY18 to 32.9% in FY21 which has improved free cash flow generation as capital expenditures have not increased meaningfully.
In those three years the valuation on EV/Sales has gone from 3.6x to 7.9x reflecting the market's increasing confidence that Apple will be able to defend its market share on hardware and grow the business by selling content, services, and subscriptions on that unit base. The robustness of the business and its upward operating margin trajectory coupled with ever lower negative real rates are increasing its market value. It is all justified for now, but if either interest rates go up by 100 basis points or the company cannot lift its operating margin, then suddenly we could see a significant in Apple’s equity valuation. But Apple is part of the mega caps vs everything else in which investors are preferring mega caps due to their predictability on cash flows and their market power providing them with the ability to pass on rising costs from inflation.
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