Do stock market indices still make sense?

Stock market indices are sets of selected companies whose prices reflect the condition of a specific market segment. For years, they have served as a barometer of the capital market and a benchmark for investors – they simplify the assessment of the economy's condition and allow for comparison of portfolio performance with the market average. Stock market indices are also widely used as investment tools, serving as the basis for various types of index funds or ETFs.

Recently, there has been an increasing amount of talk about large indices such as American S&P 500 or German DAX, may no longer reflect the full state of the economy,  They are increasingly dominated by a small group of giants, a few of the largest companies. In this article, we will examine the market consequences of this concentration and their causes.

The role of indices in investing

Historically, the main purpose of indices has been to provide an organized picture of the market. From the first index Dow Jones Since the late 19th century, the purpose of indices has been to measure the "temperature" of the market and provide investors with a broad point of reference. Major indices encompass a significant portion of the market: for example, the S&P 500 includes the 500 largest American companies, which together constitute approximately 70-80% of the total market value of all stocks listed in the US. This allows the index to reflect almost the entire stock market capitalization of the world's largest economy. At the same time, indices provide a natural diversificationInstead of investing in a single company, the investor purchases an entire group of shares. This "broad range" of industries and companies is intended to help stabilize the portfolio's performance.

Today, indices also function as a key benchmark for fund managers and individual investors. The performance of many equity funds (active and passive) is assessed by comparing them to the returns of a relevant index. As emphasized in investment literature, indices allow for the avoidance of the need for detailed analysis of hundreds of companies and offer investors a "simplified view" of the market. Index-tracking strategies are popular in investment practice, based on the belief that it is difficult to beat the "market" rate of return (i.e., the rate of return on a market index), making it better to simply invest in the index. The popularity of this way of thinking means that, despite criticism, indices play a crucial role in the world of investing.

The problem of company concentration in stock market indices

Unfortunately, the structure of the major indices indicates a significant concentration of the largest companies. In the case of the S&P 500, the importance of a few leaders is enormous. The ten largest companies in this index already account for almost 40% of its market value (data as of September 30, 2025), and the five largest – for approximately 27% of the index.

This primarily includes technology companies (e.g. Apple , Microsoft, Nvidia or A), which tower above the rest of the market in terms of capitalization. The result: price movements of these few giants have a disproportionately large impact on the entire index.

A similar concentration can be seen in DAX index (The 40 largest companies on the Frankfurt Stock Exchange). The five largest DAX companies – SAP (approximately 13,9%), Siemens (10,2%), Allianz (8,2%), Airbus (6,9%), and Deutsche Telekom (6,1%) – together account for nearly half of the index's capitalization. And when we take the top ten DAX companies, they already account for approximately 65% ​​of the index's weighting. This means that the rises or falls of a few companies largely "transmit" to the entire DAX. As a result, the index becomes a barometer primarily of the fortunes of these dozen or so companies, rather than the broader market.

This concentration means that indices can distort the market. What happens to a small group of leaders determines the index's price, while the majority of other companies may perform completely differently. These companies' stocks often completely dominate the index's chart, masking the underperformance of companies in other industries. In other words, the index can rise based on strong performance from a few companies while most components barely keep up or remain flat. i As the chart below illustrates, comparing the S&P500 weighted by capitalization vs. giving each component the same weight, this is exactly what happens in practice.

Concentration in the aforementioned S&P 500 index is currently at its highest level in history, which undoubtedly impacts its performance. In simple terms, buying the S&P 500 today is simply betting on the continued growth of the technology sector.

Potential causes of company concentration in stock market indices

Several economic and institutional factors contribute to the observed concentration. Primarily the scale and network effect works to the advantage of the largest companies todayIn technology and platform industries, thanks to globalization and cost advantages, digital giants can grow rapidly at the expense of smaller competitors. Once a company has a large user base or significant production capacity, subsequent customer or sales growth becomes increasingly less expensive. This "self-reinforcing" growth allows leaders to quickly rise to the top (we see this in the case of companies closely linked to the internet and data). This mechanism can be compared to a natural monopoly: companies that achieve a dominant position often maintain it for a long time, as clearly demonstrated by the market capitalization chart of the world's largest companies.

Another reason is the growing role passive investorsIn recent years, more and more capital has flowed into ETFs and index funds, which automatically invest in companies proportional to their market share. In practice, this means that the largest companies receive a larger share of the investment, further inflating their prices. This influx of passive funds propels large companies more than others, exacerbating the imbalance between large and small companies in the index.

Finally, macroeconomic factors – primarily the low interest rates in recent years – have favored growth and technology companies. When interest rates are low, the future earnings of high-growth companies (often in the technology sector) are discounted lower, significantly increasing their valuations. In other words, relatively cheap capital encourages investors to invest in companies with higher earnings dynamics (e.g., IT or biotechnology). Interest rate cuts typically favor growth and technology companies in particular. As a result, the era of low interest rates has increased the attractiveness of giants associated with AI and the broader internet sector, as evidenced by their dominance in market value rankings.

Consequences of Concentrated Indices for Investors

The scale of concentration influences the perception of the condition of the economy and the risk of the investment portfolio. First, the index may mislead the investor about the overall market picture. When the "America's 500 Largest Companies" index is rising, it's easy to think the economy is in great shape. However, in reality, many companies may be stagnating or declining. As a result, an investor tracking only the index may develop a false sense of confidence in sectors other than broadly defined technology simply because the index is "rising." This, in turn, can lead them to ignore potential warning signs of a potential trend reversal, which "don't matter as long as they matter."

Similarly, it was recently noted that when S & P 500 reached new all-time highs, with less than 5% of the companies in the index trading at their local highs. This weak participation of the stocks in the overall trend indicates a narrow bull market, with the index rising thanks to a few leaders while the rest of the market lags behind.

Second, concentration increases the risk of a portfolio constructed according to an index. Investments in index-tracking funds (index ETFs, passive funds) are theoretically less volatile thanks to diversification, but in practice they become highly dependent on the fortunes of a few major companies. Capital inflows into passive funds increase the weight of the largest companies and create a vicious cycle of concentration. Passive funds' market share is currently enormous, meaning that most fresh capital flows in proportion to the companies' shares in the index. The size of companies does not only grow based on their own results, but also due to the passive supply of funds, which further strengthens their importance. In other words, every zloty that goes into an S&P 500 or DAX fund invests more in Apple or SAP than in smaller companies, which leads to an even greater dominance of the "top" in the index.

Consequently, concentration can increase the market's vulnerability to sudden corrections. In practice, excessive faith in a few companies can cause the entire valuation of leading companies to detach from their fundamentals and create a speculative bubble. The larger the share of several companies in the index, the stronger the potential "domino effect" in a reversal of sentiment.

From an investment perspective, it is also worth asking whether, since an investment in the S&P 500 depends so heavily on the performance of a few companies from the technology sector, is it worth keeping 60-70% of the portfolio in the remaining 490 companies that underperform, or is it better to simply invest part of the portfolio in these few largest companies and find another alternative for the rest?

Do indexes still make sense?

Despite increasing concentration, indices still remain a useful point of reference, but with an important caveat. They continue to be a simple and widely recognized indicator of market conditions and the foundation of many investment strategies. This allows many investors to easily gauge economic conditions and compare portfolio performance with the average market. However, the caveat is that, with their current structure, the indices are increasingly less representative of the health of the overall economy and more reflective of the performance of the most powerful companies. The use of indexes therefore requires awareness of their limitations and additional analysis tools.

Investors use various methods to address these limitations. One alternative is equal-weighted indices, in which each company is given the same weight regardless of market capitalization. Another option is to independently and discreetly select companies for your portfolio, taking into account fundamental analysis, as well as investing in or observing sector ETFs, which may offer different correlations with changes in the main indices. These alternatives are worth considering to be aware of the broader market situation and build a portfolio that is resistant to index shortcomings or simply better reflects your individual investment goals.

Summary

Stock market indices continue to play an important role in investing as a measure of market trends, benchmarks, and a broad diversification tool. However, the growing concentration of highly valued companies (in both the S&P 500 and DAX) means that index movements are increasingly in line with the overall market's average performance. As a result, index growth can provide a misleading picture of economic reality.

From an investor's perspective, it is crucial to understand that the index today shows the condition of mainly market leadersIt's worth taking this specificity into account when formulating a strategy, for example, by considering alternative indices or increasing portfolio diversification to better protect against potential concentration risks. In summary, indices still make sense as a simplified market barometer, but they increasingly require informed use, taking into account their limitations.