The ASX 200: Riding on the Shoulders of a Few Giants

Over the past two years the ASX 200’s returns have been heavily concentrated. A very small group of companies — primarily the “Big Four” banks (Commonwealth Bank, Westpac, ANZ and NAB) and Wesfarmers — accounted for a disproportionate share of the index’s gains.  

Together, these five companies now make up close to 28–29% of the ASX 200, meaning their performance has a massive influence on how the overall index looks. When they rise, the market rises. Over the past two years these five stocks have delivered around 50% of the total market return. 

Valuations at the top end 

Given that Index funds buy stocks in proportion to market capitalisation, large inflows into ASX 200 index funds automatically allocates more money to the market’s biggest names — notably the Big Four banks and Wesfarmers. That automatic buying raises their share prices irrespective of company fundamentals.  

Rising share prices increase marketcap, which increases index weight, which attracts more passive buying. The net effect is concentrated index performance and stretched valuations for those large companies, creating divergence between price and underlying fundamentals. 

The “big five” are now trading at price-to-earnings ratios well above their long-term averages. For example, Commonwealth Bank is currently trading on a Price to Earnings multiple of around 25–26 times earnings, compared to its historical average near 17–18. This means that based on current earnings, an investor would receive a return of their initial investment capital after 26 to 26 years.  

To command such a multiple, investors will be demanding strong earnings growth. If Commonwealth Bank’s recent results are anything to go by, where net income was up only 2.7%, it seems strong flows into passive funds has left them, and others, looking expensive — and vulnerable if the tide turns. 

Where to look next 

While the top end of the market looks stretched, there are plenty of opportunities bubbling beneath the surface. I believe active investors — those willing to dig into individual companies rather than simply track the index — are set to outperform in the years ahead. 

Sectors that could shine next industrial, healthcare stocks, and consumer discretionary stocks that have been left behind during the recent flight to safety. 

As market momentum fades and investors start hunting for value again, these overlooked areas could be where the real growth — and outperformance — comes from.