Potential Shift Ahead: Will Big Tech’s Dominance Fade?
The S&P 500 (SNPINDEX: ^GSPC) has surged to impressive new heights in recent weeks, marking three robust years of a bull market. However, not all stocks have enjoyed similar gains.
The Growing Gap Between Big Tech and Other Stocks
In recent years, major tech companies have significantly impacted the S&P 500’s overall performance. The surge in spending on artificial intelligence (AI) has particularly benefited larger firms with the financial resources to invest. Consequently, the wealth gap between these tech giants and smaller companies has widened.
Investors are optimistic about the long-term benefits of this AI-related spending, prompting them to drive stock prices higher for these major players. In contrast, businesses lacking the capital for substantial AI investments or those less affected by AI advancements have not experienced the same valuation increases.
A Warning Signal for Investors
As tech firms excel, market concentration has become increasingly skewed towards a few top performers. For instance, the combined valuations of Apple, Nvidia, and Microsoft now represent over 20% of the S&P 500.
S&P Global provides another way to evaluate market concentration, comparing the average market capitalization of the S&P 500 to a weighted average that prioritizes larger companies. Presently, this ratio stands at approximately 10 to 1, a peak level not seen since S&P Global began tracking this data in 1970.
This concentration serves as a critical warning sign; those invested in typical S&P 500 index funds may not be as diversified as they perceive. If this trend shifts—which tends to happen—investors could face an extended period of subpar market performance. This concentration is a contributing factor to Goldman Sachs‘ pessimistic outlook for the next decade, predicting minimal market returns.
What Could Signal a Shift?
Predicting when the market may rotate away from the tech giants that have driven the S&P 500 upward is challenging. However, growing economic conditions could favor smaller businesses over time.
The Federal Reserve’s interest rate hikes and tightening money supply have amplified the advantages held by major tech companies in terms of investment capabilities in AI. A potential shift may be on the horizon as September marked the Fed’s first rate cut since 2020, suggesting a possible lengthy cycle of cuts in the years ahead. Early signs show the U.S. money supply is already expanding, hinting at a potential reversal in market concentration as soon as next year.
Investing Strategically Amidst Change
For those looking to sidestep the overconcentration of the biggest tech companies, there’s no need for detailed stock picking within the S&P 500. While companies like Apple, Nvidia, and Microsoft might maintain their stronghold for now, investors can reduce their exposure to these giants and better position themselves by investing in smaller stocks through an equal-weight S&P 500 index exchange-traded fund (ETF).
The Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP) offers a straightforward and cost-effective method to invest in an equal-weight index, with an expense ratio of 0.2%. This ETF invests equally in all S&P 500 components and rebalances quarterly.
Historically, the equal-weight index has outperformed the market-weighted version, especially in years when market concentration declines. The last several years, however, have not favored this strategy. If you believe the current high concentration will decrease, consider incorporating the Invesco fund into your portfolio.
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*Stock Advisor returns as of October 28, 2024
Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
