A small number of tech companies are driving an ever-increasing share of the US stock market’s gains, prompting concerns among investors about the sustainability of the rally.
The S&P 500 has risen 8 per cent so far in 2023, but 80 per cent of the increase has been driven by just seven companies, according to Bloomberg data. Apple and Microsoft have led the way, contributing around 40 per cent of the index’s rise as they added more than $1.1tn in combined market capitalisation.
The trend has been growing for several months. However, the gulf between the small number of winners and the rest of the market widened over the past week as strong tech earnings contrasted with mixed results in other sectors and downbeat economic data.
Stuart Kaiser, head of equity trading strategy at Citi, said many investors were growing nervous about the fragility of the rally, but were reluctant to pull back and risk missing out on further gains.
“People are considering diversifying because the [tech] outperformance has been so wide, but we’re not seeing people pulling back yet”, he said.
Big tech has benefited from enthusiasm about generative artificial intelligence, along with a belief that the sector would be relatively insulated from an economic slowdown, and expectations that the Federal Reserve is approaching the end of its cycle of interest rate rises. Many long-only investment funds are also rebuilding their positions from a low base after selling huge amounts of tech stock last year.
Nvidia, which designs high-powered chips crucial to the AI boom, has been the third-biggest contributor to the S&P’s rise, followed by Facebook owner Meta, which has rebounded from a rough 2022 to double in value so far this year. Next was Google owner Alphabet — another large investor in AI — along with Amazon and Tesla.
The stocks have gained an average of 44 per cent so far this year, compared with a 2 per cent increase in the equal-weighted S&P 500.
Sentiment about the broader market has been dominated by concerns about the economic outlook. Companies in the benchmark index are on track to report their second consecutive quarter of earnings declines, and data released this week showed economic growth slowed dramatically in the first quarter, to an annualised rate of 1.1 per cent.
“We understand why risk assets have done better through the winter,” Sonja Laud, chief investment officer at Legal & General Investment Management, said in an interview. US inflation started to back down towards the end of last year, then as 2023 got under way, Europe dodged an energy crisis and China emerged from its zero-Covid lockdowns.
“That meant we had a far better start to the new year,” Laud said. “But there’s no evidence since the 1970s that a rate hike cycle, especially as aggressive as the one we have seen, won’t lead to a recession, a financial crisis, or both. Why would this be different?”
That has left LGIM shying away from risky assets in equities and credit, and leaning more towards government bonds. Laud said the firm had asked every one of its fund managers to scour their portfolios to look for weak links that might struggle if the current slowdown turns more severe.
The cautious stance is typical among large money managers. Citi’s Kaiser said: “You can earn so much yield keeping money in cash that the hurdle rate or bar to put money into equities is quite high”.
Markets have already started to lose some of their steam. In all of April, the S&P gained 1 per cent or more in a day only twice — a tally that has gradually shrunk from six days in January. The index added 1.5 per cent for the month, the second-worst month of the year so far.
With so much of the strength resting on a small number of companies, any bad news for the tech sector — such as the Fed deciding to keep rates high for longer than investors expect — could have a disproportionate impact.
Still, some are hopeful that the rest of the market will be able to start catching up with the winners, rather than the other way round.
“Once you have extreme readings like leadership in a few stocks, that’s usually signalling the fact that things are already quite bad . . . it’s a sign more often that the market is bottoming,” said Denise Chisholm, director of quantitative market strategy at Fidelity.
“I understand the behavioural bias of people intuitively waiting for the last shoe to drop, but the data doesn’t support it when you look at the history of equities.”