Some Perspective for the 2nd Half
A little bit more than half way through 2024 and the S&P 500 is having a great year, up 18.6% year to date (YTD) and 27.5% over the past twelve months. We’ll gladly take it and be thankful for it. That top-line strength hides both pitfalls and opportunities.
Mostly, everyone is quite aware of the mega-cap tech stocks’ performance for 2023 and 2024 YTD. Much of their performance has been driven by strong topline growth, underlying earnings, and the optimism around artificial intelligence. These so called “Magnificent Seven” are up 45.3% YTD and 58.3% over the last twelve months, while the remaining S&P 500 (call it the S&P 493) have risen only 10.6% YTD and 17.3% over the last twelve months. Meanwhile, the tech-heavy Nasdaq 100 is up 21.4% and 34% over the same time periods. In contrast, the S&P 500’s Equal Weight Index is up only 7.8% YTD and 12.7% over the last twelve months. Looking further afield, we see that the Russell 2500, which tracks small and mid-cap stocks, is up only 6.2% YTD and 11.8% over the last twelve months. Clearly, the mega-cap tech stocks are leading the market higher and leaving everything else essentially in the rear-view mirror.
But this strong outperformance has led the largest stocks (by market capitalization) to become even larger as a percentage of the overall market. As of early July, the ten largest companies comprise 37.4% of the market and the top-three names make up 20.9%. This is the largest market concentration for the top-ten names in over forty years (chart below). Microsoft, Apple, NVIDIA, Amazon, Meta Platforms, Alphabet, Broadcom, Berkshire Hathaway, Eli Lilly, and Tesla make up that top ten. The fact that these stocks have grown so much larger in market capitalization relative to the rest of the market reflects both their sales and profits growth, but also the expansion of their corresponding valuations relative to earnings. The Mag-7 are currently trading at 36x and the other 493 names are trading at 20x. Broadcom, Berkshire Hathaway, and Lilly, the three companies that aren’t among the Mag-7, are trading at 35x, 20x, and 69x respectively. TSLA at 100x and NVDA at 48x are the two most expensive Mag-7 stocks and Alphabet at 24x and META at 24x are relative bargains compared to the rest of the group. Further, the reader should know that these valuations for all the top-ten other than Berkshire Hathaway are at, or very near, multi-year highs in valuation. The point of this exercise isn’t to deluge you with numbers, but rather to provide some perspective as to where things currently stand in the overall market.
As one might expect, investment flows have followed, or some would say, chased the strong return numbers of these most-loved companies and their valuations reflect this. We should also note that these very popular stocks in the top-ten tend to change over time. New companies seem to come “out of nowhere” and supplant the incumbents. Ten years ago, only four of the current top-ten were in the top-ten to start 2014. Those four were Apple, Alphabet, Microsoft, and Berkshire Hathaway. And the list from twenty years ago includes only one company still in this group today, Microsoft. The point being here is that it’s difficult to continuously grow revenues at a pace that keeps the multiple at least in its current place to stay in the vaulted mega-cap and most loved company status. This brings us back to the point that the market’s concentration has meant that other parts of the market have largely been ignored. Real estate, materials, energy, and health care are the weakest performing sectors year to date. They’ve also been the most impacted by the Fed’s higher-for-longer interest rate policy. Going back to the top-ten names – exceptionally strong growth in their top- and bottom-line numbers are the main drivers of their share price growth. In other words, they’ve earned their current positions and status. And then the excitement over AI has only meant more interest in owning these names. But the current top-heavy concentration in the market is historically very high and may not be sustainable. We don’t know how long it will last. We’re reminded of the adage that the “market can stay irrational longer than you can stay solvent.” But sometimes it’s wise to take the other side of a very crowded trade.
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