Investors sitting on the sidelines, waiting for the next shoe to drop, have missed out on the year-to-date gains of a small number of S&P 500 stocks largely responsible for this year’s 8.31% gain in the large-cap index. Those stocks, and their returns, are:
- Apple Inc. (NASDAQ: AAPL): 33.59%
- Microsoft Corp. (NASDAQ: MSFT): 29.53%
- Nvidia Inc. (NASDAQ: NVDA): 96.25%
- Alphabet Inc. (NASDAQ: GOOGL): 19.65%
- Amazon.com Inc. (NASDAQ: AMZN): 25.99%
Apple and Microsoft alone account for 14.15% of the entire S&P 500. When you include the other four stocks named above, your total is nearly 24% of index weighting.
That’s a problem for the broad market. The purpose of an index is to track a broad, diversified basket of stocks, which, in theory, offers a wide lens on overall market and business cycle activity.
Are Investors Diversified Now?
For investors who hold ETFs such as the SPDR S&P 500 ETF Trust (NYSEARCA: SPY), the selling point has always been broad sector and industry diversification. The thinking goes, if techs have a rough year, maybe consumer staples or industrials will pick up the slack.
But when a small number of companies, all from the same sector, are so dominant, that changes the role of an index or index fund.
In addition to all of the above stocks hailing from the tech sector, there’s another factor driving much of the growth: AI. With several stocks in the list, it’s pretty clear to see the connection, and it’s been covered extensively by MarketBeat.
Apple hasn’t formally announced AI initiatives, as some of the others have, In the company’s most recent earnings conference call, CEO Tim Cook responded to an analysts’s question about AI plans, saying, “I do think it’s very important to be deliberate and thoughtful in how you approach these things. And there’s a number of issues that need to be sorted, as is being talked about in a number of different places, but the potential is certainly very interesting.”
Apple is recruiting for team members with expertise in AI and machine learning in its various groups.
With Amazon, most investors immediately think of the e-commerce applications, and those blue vans pulling up to the driveway. But one big line of business is Amazon Web Services (AWS), which accounts for about 14%, or $21.4 billion in revenue for the company.
Machine Learning In The Spotlight
Amazon touts AWS’ machine-learning services to prospective customers. In addition, its warehouses and other operations are increasingly driven by AI. It’s also boosting its podcast features with a new AI acquisition, a privately held company called Snackable AI.
In an April 25 research note, J.P. Morgan’s global markets strategies team pointed out the lack of market breadth in the S&P 500 this year, calling it the “ narrowest stock leadership in an up market since the 1990s.”
The J.P. Morgan analysts specifically cited market-cap creation of $1.4 trillion among a small number of stocks, due to interest in generative AI and large-language models.
The analysts termed this phenomenon “mega-cap crowding,” and added that the current level of mega-cap crowding implies that the risk of recession is not priced into markets.
They also cited a strong upside in Salesforce Inc. (NYSE: CRM), which is not among the top 10 most heavily weighted S&P 500 stocks, but also benefited from interest in its AI endeavors. Salesforce boasts a year-to-date return of 49.02%, putting it among the index’s top gainers.
Concentration Risk
While concentration risk is very much a real concern in portfolio allocation, there’s also the reality that about three-fourths of stocks tend to follow the market’s direction. While techs got hit especially hard in 2022, energy and utilities were the only sectors with a gain, and utilities eked out a gain of 1.69%, doing their job as defensives, and helped by dividends.
It’s never a bad idea to diversify and spread the risk. Investors with an outsized concentration in large tech stocks that have been going gangbusters this year should monitor their holdings closely. If they show signs of selling off, such as falling below their 50-day averages, it may be time to pare back and take some profits.
