Too much of a good thing can be bad — and that’s exactly what Goldman Sachs’ top equity strategists are concerned about when it comes to the stock market. 

The slam-dunk trade of this year — and of the era since the 2008 financial crisis — has been to bet on large, rapidly growing technology stocks. At a sector level on the S&P 500, tech has delivered the biggest bounty of the past decade, including a chart-topping return of 15% in 2020.

The problem is a handful of companies is driving the majority of these gains both within the sector and marketwide. We’re talking about none other than the famous FAAMGs: Facebook, Amazon, Apple, Microsoft, and Google parent Alphabet.

Their market caps have swelled by a third in 2020, resulting in them holding a 22% share of the S&P 500. That’s the largest concentration of any group of top-five stocks since at least 1980, and up from the peak of 18% during the tech bubble, Goldman Sachs’ data shows. 

“From a macro perspective, record concentration means the S&P 500 has never been more dependent on the continued strength of its largest constituents or more vulnerable to an idiosyncratic shock to any of these stocks,” said David Kostin, the chief US equity strategist at Goldman Sachs, in a recent note. 

To illustrate what is at stake, Kostin separated the so-called FAAMG stocks’ returns this year from the remaining companies on the S&P 500. The chart below shows these mega caps have returned 35% while the S&P 500 has returned 2%. And if these companies are excluded, the remaining 495 constituents would be down by 5% year-to-date.

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Goldman Sachs

In essence, any major slip-up in the upper ranks of the index could result in huge losses for the broader market. The pain would be felt far and wide, from exchange-traded fund owners to mutual fund managers who have piled into these stocks for their income.

Kostin further illustrated the concentration problem as follows: if the FAAMGs fell by 10%, the bottom 100 S&P 500 stocks would have to rise by a collective 90% just to keep the index flat. 

He is not forecasting a 2000-like implosion of the big five. Of course their valuations are elevated — at 31 times 2021 earnings per share versus 18 times for the rest of the S&P 500. But this premium still falls short of the high watermark left during the tech bubble. And this time around, the top stocks actually have earnings growth and quality balance sheets to show for their performance. 

This means the largeness of these companies is not a risk in and of itself — it’s what happens if the fundamentals that have inflated them suddenly change.

What might trigger such a change? Kostin has a few ideas: “From a micro perspective, elevated multiples, a rapidly-shifting macroeconomic backdrop, portfolio weight limits, crowding, and potential regulation represent the key risks to the future absolute and relative returns of today’s market leaders,” he said.

Goldman’s own tech analysts recently flagged a some pandemic-related risks specific to Apple. 

In a note, the team led by Rod Hall recommended that investors avoid buying shares until the coronavirus-induced fog surrounding the company’s outlook clears. They also flagged that these uncertainties — and the lack of official forward guidance from executives during the next earnings call— raise questions over whether the next iPhone will arrive on time this fall. 

Regardless of whether these risks actualize, one fact remains: as these companies go, so goes the broader market. And that is why investors cannot afford any blunders by any of them.

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