This year stock market rally has been run by just a few big tech names.
While it may seem worrying to bet too much on a handful of stocks, strategists say this trend may not be a bad thing for the markets.
“We view a small group of technology winners leading stock gains as a feature of the artificial intelligence (AI) theme and not a flaw,” Jean Boivin, director of the BlackRock Investment Institute, wrote in a note Monday. of research. “We remain overweight on US equities.”
AI darling Nvidia (NVDA) accounted for nearly a third of the S&P 500’s gains this year, and outperformance of quarterly results of large technology caps continues to be one of the reasons why S&P 500 earnings are increasing year over year.
As of Monday’s close, Apple (AAPL), the alphabet (GOOG, GOOGLE), Microsoft (MSFT), Amazon (AMZN), Meta (META) and Broadcom (AVGO) had also contributed to more than a quarter of the main index’s gains.
A potential concern is that the market could be in danger if a few big tech companies that have generated the lion’s share of gains stop surprising on the upside.
However, research by Morgan Stanley chief investment officer Mike Wilson shows that this might not be a problem.
Wilson found that about 20% of the top 500 stocks outperform the broader index over a rolling one-month period. This is the lowest percentage of outperforming companies in Wilson’s data set dating back to 1965.
Wilson’s work notes that after similar readings on a narrow scale, where fewer than 35% of companies outperform the index in any one month, the S&P 500 rose about 4% on average over the following six months.
“Narrow breadth may persist, but it is not necessarily a hindrance to returns in and of itself,” Wilson said. “We believe the expansion will likely be limited to high-quality, large-cap pockets for now.”
Wilson argued that when you consider the impact of high interest rates on businesses, this makes sense. Investors have flooded into large market-cap stocks that have weathered the higher interest rate environment well and are seeing earnings growth more than their smaller-cap counterparts.
And one series of recent S&P 500 year-end target upgrades reflect a similar feeling. Three Wall Street firms cited tech outperformance as one reason the index is doing better than they initially thought this year.
Evercore ISI’s Julian Emanuel increased his target from 4,750 to 6,000, citing the “early days of AI” and a market supported by the “persistence of AI exuberance.” Citi’s Scott Chronert raised his year-end target from 5,100 to 5,600, noting that “the weighting effect of the mega-cap growth cohort exerts an outsized influence on the index’s price action.” .
Goldman Sachs’ equity strategy team raised its year-end target to 5,600 from 5,200, noting that rising earnings expectations for Alphabet, Microsoft, Amazon, Meta and Nvidia have “offset the typical pattern negative revisions to consensus EPS estimates.
“We underestimated how much these earnings would boost these few stocks and how much these few stocks would boost the rest of the market, and that’s basically what we’re adjusting for,” said Ben Snider, equity strategist from Goldman Sachs to Yahoo Finance. .
Goldman Sachs presented an alternative scenario to its base case forecasting 5,600 on the S&P 500, where the benchmark index climbs to 6,300 by the end of the year. According to the Goldman team, this situation would be motivated by “greater exceptionalism of mega-caps”.
Snider told Yahoo Finance that this possibility would likely come from “continued revenue above what analysts expected.” Snider added that such a scenario leaves investors “vulnerable” to a few stocks beating expectations. But it still has an advantage.
“The beauty of owning the S&P 500 in general is that when a few companies perform really well, they can drive the entire index higher,” Snider said. “And we’re seeing that now. So I think most investors who own the S&P 500 are very happy with what’s happened, even if it means their underlying portfolios are more concentrated,” Snider said.
Josh Schafer is a reporter for Yahoo Finance. Follow him on @_joshschafer.
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