Financial Forum - July 2024

Daniel A. Cesta, CPA, CFP®, MST |

Financial Forum - July 2024

Market Commentary – Concentration Risk Increases as Stocks Continue Their Ascent

  • Concentration risk, which started last year with the Magnificent Seven, has only increased in 2024, as artificial intelligence (A.I.) optimism continued to lift stocks in the second quarter.  2023’s Magnificent Seven (Apple, Microsoft, Amazon, Alphabet, Nvidia, Meta, and Tesla) are now dubbed the Fab Five, as Tesla and Apple have struggled with sales amid increased competition and stale product developments.  The top three largest companies by market cap (Microsoft, Apple, and Nvidia) are now larger than the entire Chinese stock market.  And, according to Investopedia, Nvidia's soaring market cap has, in recent weeks, come to exceed that of the entire German, French, and U.K. stock markets, respectively.

Below are some other stats that show how top-heavy today’s market is:

  • Midway through the year, more than two-thirds of the S&P 500's gains for the year have come from Nvidia, Apple, Alphabet, Microsoft, Amazon, Meta, and Broadcom.  Nvidia alone has driven nearly one-third of these gains.  (Source: Yahoo Finance)
  • Three stocks in the S&P 500 (Microsoft, Apple, and Nvidia) ended the quarter with market caps of more than $3 trillion.  The combined $9.7 trillion of market cap of these three stocks is roughly the same as the smallest 350 stocks in the index.  (Source: Bespoke)
  • The top ten companies in the S&P 500 make up 35% of the index’s market cap, but only 23% of the index's profits.  (Source: Apollo Group)
  • The largest 30 stocks in the S&P 500 had a combined index weighting of approximately 53%.  During the dot-com bubble in 1999, the 30 largest S&P 500 companies made up “only” 42% of the index.  (Source: Bespoke)
  • The average large cap fund has a third of its portfolio in just five stocks and a quarter of all large cap funds have more than 40% of their portfolio in five stocks.  (Source: Bank of America)
  • The price-to-sales ratio of the S&P 500 technology sector rose to 9.8 as of June 18, which is more than three times its average reading of 3.2 since 1990 and more than two points higher than its dot-com bubble high of 7.5.  It is also seven points higher than the small cap Russell 2000 tech sector’s price-to-sales ratio of 2.8.  (Source: Bloomberg)
  • It was an uneven quarter for the S&P 500, with just under 40% of the index’s components ending in positive territory.  Additionally, the equal-weight S&P 500 index, which holds the same amount of each stock, was negative in the second quarter.  (Source: Barrons)
  • Despite some short-lived rallies throughout the year, just two sectors have outperformed the S&P 500 this year: Communications Services and Information Technology.  (Source: Yahoo Finance)


Bottom Line:  Although the stock market hit a new high in the second quarter, most stocks are struggling.  Healthy markets have broad-based rallies, meaning a large percentage of stocks, from many different sectors, participate in the rally.  The fact that a handful of stocks are doing most of the heavy lifting and that the equal-weighted S&P 500 ETF can’t surpass its previous record high, is a warning sign that needs to be resolved.  Either the Top 30 stocks will help lift the smaller stocks or the lack of a broad-based rally will act as an anchor on the market that will eventually bring down the indexes.  


What are we monitoring in the second half of the year?

Growth – In our opinion, the most crucial factor supporting today’s market is growth.  The market is priced for perfection, selling around 22-23 times forward earnings.  If growth rolls over, we’re looking at a stagflation environment, which historically is not good for stocks or bonds.  If we get stagflation, the market could easily trade for a multiple of 15 or lower, which could mean a drop in the S&P 500 of 1,000 points or more.


A.I. turns out to be more hype than transformative – While A.I. hasn’t been the reason stocks have rallied, it certainly has contributed to the size of the gains.  If investors begin to question the transformative power of A.I., that will add downward pressure on tech stocks, which will not only weigh down the S&P 500, but also create downward valuation pressure as earnings estimates will fall.


Interest Rates – After last week’s benign inflation report, rate hikes are most likely off the table.  However, if future reports show a reacceleration in prices, then investors would have to reprice the market and most likely give back a significant portion of the October 2023 – March 2024 rally, which was predicated on the Fed cutting rates six times in 2024.  


Oil Prices – If oil prices spiked, the most likely reason would be escalating conflicts in Russia/Ukraine and Israel/Hamas.  If either (or both) of these wars spread regionally, it could easily interrupt global shipping.  Rising oil prices would increase headline inflation, and while the Fed largely looks past short-term energy price increases, the optics and politics of high oil and higher inflation would likely eliminate the possibility of rate cuts.


As always, we are closely monitoring the situation.


Quarterly thought…Happy Birthday, America!


“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator, with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.” 

— The Declaration of Independence, 1776


Though it's hard to believe, Lady Liberty is celebrating 248 years of freedom this Fourth of July. (Although I don’t think she looks a day over 200!)  


Enjoy your Fourth of July celebrations and take a moment to honor all those who sacrificed for our freedom.


Happy Birthday, America!

Daniel A. Cesta, CPA, CFP®, MST   
Pinnacle Wealth Management Group, Inc.

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*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

* The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.