The remarkable performance of the Magnificent 7 tech stocks has played a significant role in driving the S&P 500 to reach record highs this year. However, this success also presents opportunities outside the tech sector.
According to Dow Jones Market Data, the S&P 500 has witnessed a staggering $588 billion increase in market capitalization so far this year. This brings the total to a whopping $40.626 trillion. Remarkably, a large portion of this gain, approximately $463 billion, can be attributed to the stellar performance of seven tech giants: Tesla, Nvidia, Meta Platforms, Alphabet, Microsoft, Apple, and Amazon.com. In comparison, the remaining 493 companies in the index accounted for just $125 billion of the overall gain.
The surge in Big Tech’s performance has boosted the S&P 500 by approximately 2% this year. Without this impetus, primarily fueled by optimism surrounding artificial intelligence, the index would have remained relatively stagnant, hovering near its previous record high set in January 2022.
A telling comparison can be observed between the S&P 500 and its equal-weighted counterpart. The traditional S&P 500 is weighted according to the market capitalizations of its constituent companies. Therefore, movements in large firms like Apple and Microsoft exert a disproportionate influence on its overall performance. Conversely, the equal-weighted index reflects the performance of an average stock.
Thus far, the Invesco Equal Weight S&P 500 exchange-traded fund has experienced a slight decline, while the standard S&P 500 has reached new highs.
Interestingly, this underperformance relative to the market-cap weighted index has resulted in lower valuations for a majority of stocks compared to both the S&P 500 and Big Tech. According to FactSet, the equal-weighted index is currently trading at a price-to-earnings ratio of 15.9 times analysts’ expectations for aggregate earnings per share for the upcoming year. This represents a 20% discount compared to the standard S&P 500’s P/E ratio of 19.8 times.
This disparity is one of the largest discounts observed in at least the past five years.
As economic growth continues, accompanied by increased earnings across various sectors, the appeal of the average stock is expected to further rise. Despite facing headwinds from the 11 rate hikes implemented by the Federal Reserve since March 2022, businesses are still actively hiring, and wage growth has outpaced inflation over recent months. These positive trends bode well for the demand for goods and services, further supporting the potential for stock market growth.
The Economy and the Stock Market: A Promising Outlook
As the economy continues to show signs of strength, experts anticipate positive growth across various sectors. The expected decline in inflation may lead to interest rate cuts by the Federal Reserve, resulting in more money available for both consumers and businesses to spend.
According to FactSet, analysts predict a significant increase of 4.7% in annual sales for S&P 500 companies over the next three years on an equal-weighted basis. As inflation moderates, this growth in sales is likely to improve profit margins, providing companies with additional cash flow that can be used for share buybacks.
Furthermore, FactSet suggests that the consensus forecast is for earnings per share (EPS) to rise around 12% annually over the next three years.
Chief Investment Officer at BMO Wealth Management, Young-Yu Ma, believes that the stock market outlook will improve in the second half of the year. With anticipated rate cuts from the Federal Reserve and improved consumer and corporate spending conditions, investors are actively seeking opportunities beyond the tech sector to capitalize on market performance.
In light of these factors, stocks with reasonable valuations and growth potential are expected to experience significant gains. Dennis DeBusschere from 22V Research suggests that profitable non-mega-cap tech stocks may particularly benefit if concerns about growth and rate cuts ease.
While long-term gains are expected for big tech companies due to their faster-growing profits, it is possible that these stocks may experience a temporary setback. Consequently, it may be beneficial to explore other sectors as average stocks may gain momentum in the near future.
In conclusion, the economic landscape is displaying positive indicators, and the stock market is set for potential growth. Investors are advised to consider a diversified approach beyond just technology stocks and focus on opportunities with reasonable valuations and growth potential.
