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BOOK YOUR FREE STRATEGY SESSION NOW >>What happens when a massive stock index like the S&P 500, made up of the 500 largest US companies by market capitalization, is driven by just a handful of stocks?
If you’re thinking this sounds like the Dot-Com Bubble, you’re right. It’s a very similar situation and one worth pondering.
Especially since, once again, these few driving stocks are all tech-related, just like back then, and fall into the “Growth” category, which are known for their strong growth prospects but differ in tangible value from “Value” stocks.
This is a genuine financial anomaly that is catching the eye of more and more analysts. It’s a scenario where a few stocks pull the index up while most others lag behind.
Have you heard about this?
Watch today’s video to find out:
-Why this is an unusual situation and what we can expect next
-Whether there’s a risk of another bubble
-What are “Growth” and “Value” stocks
-Tips on how to navigate this situation
Curious yet?
Enjoy the video! 😉
Is the US market driven by just a handful of stocks?
In the first half of 2024, the S&P 500 and Nasdaq hit new record highs. The U.S. stock market inflows also rose to top levels and stock indexes became more and more present in investors’ portfolios.
It all seems to be going perfectly, with no apparent issues.
But reality, as this meme humorously suggests, might be quite different.
Many analysts, examining market data, are finding that the American market rally might actually be driven by just a few stocks, perhaps five or even fewer, and by an unusually abnormal economic situation whose duration is unknown.
In this video, we want to delve into this potential issue.
I'm one of the coaches at Unger Academy, and let's dive right in.
Let’s dive into the performance numbers
If we look at the returns of the major U.S. stock indices since the beginning of the year, we've seen about a 15% gain, making it one of the best markets ever in terms of year-to-date returns, at least until a few days ago, when we saw a significant pullback.
And all this is happening in an election year in the U.S., which typically brings more market turbulence.
Who are the “Magnificent 8” and why are they leading the market?
But as mentioned earlier, this market is moving in a somewhat peculiar way, because its performance is driven by very few stocks: the famous Magnificent 8, namely: NVIDIA, Netflix, Meta, Alphabet (Google), Amazon, Microsoft, Apple, and let's include Tesla as well.
Upon closer inspection, it's not even all eight driving the index, because it's practically only NVIDIA leading the way, while the others are somewhat trailing, with Tesla even slightly negative.
If we take only the top 5 stocks by market capitalization, they account for about 25% of the entire S&P 500.
This means that these stocks have not only grown tremendously, but their weight is so significant that they are responsible for 25% of the index's performance.
While the remaining 495 stocks in the basket define the other roughly 65%.
So let's keep this concept in mind: there are few stocks that carry a lot of weight within the S&P 500 index.
Only a few stocks… and they’re all in tech
Another fundamental aspect is that these few stocks that primarily move the index are essentially tech stocks, which we could categorize in the so-called growth sector, meaning stocks with strong growth prospects, in contrast to the value sector, which includes stocks that might have fewer growth prospects but with more established and stable businesses, perhaps with excellent dividends and profitability, but typically less innovative and therefore with fewer growth prospects.
Well, as seen in this graphic we found online, 65% of the stocks today are primarily invested in growth stocks, meaning the magnificent eight we mentioned earlier.
How does this compare to the Dot Com Bubble of 2000?
And this is not very different from the value we saw during the Dot Com bubble of 2000, where there was also a strong inclination towards tech stocks.
This doesn't necessarily mean we are facing a new bubble, but it is certainly something to reflect on and monitor.
At the same time, we might say that if the market is favoring growth stocks, it is neglecting value stocks.
As seen in this graph, value stocks have had their second worst year since 1990.
It's interesting to see that in a year like 2000, which we mentioned earlier, during the tech bubble, what happened afterward, from 2000 to 2007, was a reversal of this situation, so a context in which, instead, value stocks outperformed growth stocks. This is something to keep in mind.
It's just an observation, of course, looking at past data. It doesn't mean it will necessarily repeat, but we need to understand what is different now compared to 2000 and if what happened in the past can somehow give us an indication for the future.
We can definitely say that in the past, after such performance excesses, we have seen reversals of the situation, with previously neglected market segments becoming more appreciated by investors in subsequent periods.
The role of artificial intelligence in shaping the market
Returning to the current situation, we can say that artificial intelligence has probably given birth to one of the least participatory rallies ever seen, meaning led by very few stocks, as we have seen.
When we are in this situation, market-cap-weighted indices like the S&P 500, where the stocks with the largest capitalization weigh more, tend to outperform Equal Weight indices, where each stock weighs equally.
And we can find confirmation of this in this Fidelity estimate, which quantifies about 2000 points difference between the index made up of the top 10 stocks by market cap and the remaining 490 of the S&P basket.
It's further confirmation that only a few stocks are growing, specifically the largest capitalization stocks, while the rest of the market is behaving very differently.
Market sentiment: an additional indicator
Another signal comes from observing market sentiment, so we could say the emotions investors feel about the market, such as greed and fear.
Particularly on the Nasdaq, we see that we are at an overbought level not seen since 2018, even since 2012, according to this graphic, confirming that investors are still betting on the stock market, but only on these few stocks.
Beyond this recent market correction, there is also a lot of speculation on these stocks, meaning the level of leverage used to invest in these stocks in the U.S. stock market, in particular, is very high.
So ultimately, there is a lot of optimism, we can't say there is an excess of optimism, but there is certainly optimism.
We remain in a context where markets believe in it. Market volatility is, however, very low.
A unique financial phenomenon
We are practically between 10 or 15 VIX, which is historically quite low, confirming that we are facing a paradox where the market is rising, but most stocks are either not rising or growing sluggishly.
So we are in a financial anomaly, a rather rare case, we could say, because usually when markets rise, volatility also increases.
And also in terms of earnings, which are the main measure of a company's value, if we look at the estimates for the magnificent eight or magnificent five, if we prefer, analysts see a 38% earnings growth over the next 12 months, while for the remaining 495 stocks in the index, zero or even negative growth is expected.
How long can the AI rally sustain itself?
Under these conditions, the real question we ask ourselves is how long will this artificial intelligence rally last?
We hope there won't be an artificial intelligence bubble, like the Dot Com bubble in 2000, but the similarities are many.
This is a risk we all need to be aware of and manage in our trading or investment activities.
On the one hand, we would like the tech stocks that are doing so well to continue beating the markets, on the other hand, we know that historically this is unlikely to happen, so let's keep this in mind.
And that's all for today. If you are interested in topics like this or if you are interested in systematic trading, I recommend clicking the link in the description and we will see you in the next Unger Academy video.
We'll help you map out a plan to fix the problems in your trading and get you to the next level. Answer a few questions on our application and then choose a time that works for you.
BOOK YOUR FREE STRATEGY SESSION NOW >>Andrea Unger here and I help retail traders to improve their trading, scientifically. I went from being a cog in the machine in a multinational company to the only 4-Time World Trading Champion in a little more than 10 years.
I've been a professional trader since 2001 and in 2008 I became World Champion using just 4 automated trading systems.
In 2015 I founded Unger Academy, where I teach my method of developing effecting trading strategies: a scientific, replicable and universal method, based on numbers and statistics, not hunches, which led me and my students to become Champions again and again.
Now I'm here to help you learn how to develop your own strategies, autonomously. This channel will help you improve your trading, know the markets better, and apply the scientific method to financial markets.
Becoming a trader is harder than you think, but if you have passion, will, and sufficient capital, you'll learn how to code and develop effective strategies, manage risk, and diversify a portfolio of trading systems to greatly improve your chances of becoming successful.
