What happens to the ASX 200 if CBA experiences a selloff?

Commonwealth Bank (ASX: CBA) has become a colossus on the local share market, claiming more than 10% of the entire ASX (by market cap) and establishing itself as the country's largest listed company by a wide margin. But new research suggests this dominance may not be as unprecedented — or as concerning — as many investors believe.

A 30-Year Rise to the Top

CBA's journey to market leadership has been decades in the making. While the bank's share price surged over the past year, its growing weight in the Australian market represents a steady climb spanning three decades. This endurance through multiple economic cycles mirrors that of mining giant BHP, which has maintained its mega-cap status over time.

The bank's dominance stands in contrast to other former market leaders like Telstra, News Corporation, and CSL, whose reigns at the top were relatively brief, and tied to specific market themes — the dot-com boom for Telstra and News Corp, and healthcare premiums during market uncertainty for CSL.

Market Concentration: Nothing New Under the Sun

Despite widespread concern about market concentration, UBS says Australia's equity market is no more dominated by a single stock today than it has been historically. The analysis examined four previous instances where the top stock reached peak market weight: Telstra in July 1999, News Corp in March 2000, BHP in February 2009, and CSL in March 2020.

Source: UBS

Source: UBS

These cases show an even split between market peaks and troughs, with some companies reaching their peak weights during bull market waves while others peaked during bear market bottoms.

The Myth of Easier Stock Picking

A common investment theory suggests that once a dominant stock passes its peak, stock picking becomes easier as correlations fall and individual company performance spreads out more. However, historical evidence doesn't support this belief. The data shows no clear pattern of improved stock selection opportunities following a market leader's decline.

Similarly, the idea that foreign investors drive stocks to peak weights and then abandon them doesn't hold up to scrutiny. Analysis of international buying patterns during these peak periods shows no consistent reversal in offshore investment flows.

Lessons from Market History

The most striking finding involves what happens to sector peers when a market leader stumbles. Rather than providing refuge, companies in the same sector as the declining giant typically suffer similar fates.

When News Corp crashed after the dot-com bubble burst in 2000, rotating into other media and technology stocks proved painful, as these companies experienced equally sharp declines.

Share price action through News Corp's peak (Source: UBS)

The same pattern emerged when CSL peaked in March 2020 — other healthcare stocks offered little protection.

Share price action through CSL's peak (Source: UBS)

The research suggests that whatever causes a market leader to peak often affects the entire sector, making within-sector rotation a losing strategy.

Banking Sector Vulnerability

This historical pattern has particular relevance for Australian banks today. UBS analysts note that all four major banks appear expensive based on their price-to-earnings growth ratios, offering little fundamental appeal for investors looking to rotate within the sector.

If CBA does correct, the research suggests other banks would likely follow suit, as the trigger would probably affect the entire banking sector rather than being specific to CBA alone.

Where to Look Instead

For investors concerned about CBA's dominance, history suggests looking beyond the banking sector entirely. UBS points to large-cap healthcare stocks as a potential alternative, citing their relatively attractive valuations, ability to attract investment flows, and prospects for earnings growth.

The key takeaway for investors is that when market giants fall, the pain often spreads throughout their sectors. Rather than trying to pick winners within the same industry, successful navigation of these periods has historically required broader diversification across different parts of the market.