Following on from my article on Friday about inflation, today I am drilling down further into what has really been powering the stock market, and specifically the tech sector.
Since January, seven companies with the largest market cap in the Nasdaq 100 and S&P 500 have significantly influenced the stock market, creating a unique phenomenon with implications for future market movements.
This year, the market rise hasn’t been beneficial for all companies. Excluding the top seven, there’s a large spread in returns, over 1000 basis points.
There are two implications:
1. Indices will refactor the importance of these seven companies due to strict rules about index composition. The Nasdaq 100 announced a reduction of the top seven’s influence from 55.1% to 43.7%, leading many funds to sell these companies to rebalance.
2. If the market rises, the other companies are likely to benefit first, potentially closing the “spread” between the weighted and unweighted index.
of the top-performing companies in the Nasdaq 100 and S&P 500, which have significantly influenced the stock market, five out of seven are predominantly involved in the AI and SaaS (software as a service) sectors. These companies have demonstrated the potential of AI and SaaS in driving growth and profitability. Their performance underscores the growing influence and importance of these sectors in the modern economy. As these industries continue to evolve and innovate, they are likely to remain key drivers of market performance.
Analyzing the top seven, two companies – NVIDIA NASDAQ:NVDA and Tesla NASDAQ:TSLA – are compounding share, revenues, and profits. One company – Meta Platforms NASDAQ:META – has improved its spending habits, benefiting investors short-term. One company – Apple [NasdaqGS:AAPL] – is a consistent grower. Two companies – Alphabet NASDAQ:GOOGL and Amazon NASDAQ:AMZN – are somewhat uncertain, but owning them could be beneficial due to potential strong quarterly results.
Two reasons investors may stay away
Overall, aside from the first two, there seems to be significant potential for the rest of the index to catch up and close the gap. Or does it? There are two factors that could still be stopping investors from going all-in on the stock market and even the tech sector.
1. High Stock Prices: Due to the rally this year, stocks still appear to be quite expensive. The forward Price/Earnings (P/E) estimates on the S&P 500 are at 19.4x, and the earnings yield is at 4.5%. This is compared to the 12-month US Treasury yield of 5.25%, suggesting that the equity risk premium has all but vanished, unless compared to 10-year Treasuries.
2. Inverted US Treasury Yield Curve: The yield curve for US Treasury bonds is significantly inverted, with a 10-year spread of – 1.5%. This means that a 3-month bond yields 1.5% more interest than a 10-year bond. Historically, such a scenario has often been a strong indicator of an impending recession.
We can see the correlation of inverted yield curve normally happens before the stock market depreciate.
