Mega-cap technology stocks have been the market leaders in 2023.
The Nasdaq 100 Index, which is heavily weighted towards mega-cap technology stocks, has posted its strongest first half in 40 years. This is due in part to the strong performance of AI stocks, such as Nvidia and Tesla.SourceMoneyGuru-https://www.mgkx.com/5052.html
The largest seven stocks by market cap (Nvidia, Tesla, Meta, Apple, Amazon, Microsoft, and Alphabet) have added a stupefying $4.1 trillion in market value this year. This market-cap total is greater than the combined size of the bottom 240 stocks in the S&P 500 Index. Perhaps even more astonishing, Apple and Microsoft are each larger than every stock in the Russell 2000 Index combined.SourceMoneyGuru-https://www.mgkx.com/5052.html
This concentration and high valuations could lead to less diversification.
The concentration in the market has grown to unprecedented heights in 2023. This is due to the strong performance of mega-cap technology stocks, which have become increasingly dominant in the indexes.SourceMoneyGuru-https://www.mgkx.com/5052.html
The five largest U.S. stocks (Apple, Microsoft, Alphabet, Amazon, and NVIDIA) have many advantages, including sticky ecosystems, mature installed bases, vast economies of scale, large addressable markets, and strong balance sheets. However, their enormous market caps are accompanied with commensurately high valuations relative to the rest of the market.SourceMoneyGuru-https://www.mgkx.com/5052.html
This concentration and high valuations could lead to less diversification in portfolios. This is because investors who invest in passive strategies that mirror the indexes are increasingly exposed to the same five stocks. This could make portfolios more vulnerable to idiosyncratic risks, such as a decline in the stock price of one of these large companies.SourceMoneyGuru-https://www.mgkx.com/5052.html
Mid- and small-cap stocks could be catalyzed by the physical economy.
Over the past several years, many large- and mega-cap stocks have enjoyed sustainably higher profit margins due partially to a globalized, lower inflationary backdrop. However, as supply constraints became more challenging throughout the COVID pandemic, the fragility of global supply networks prompted many corporations to move their operations back to the U.S.SourceMoneyGuru-https://www.mgkx.com/5052.html
In addition, the post-COVID hangover exposed the chronic underinvestment in U.S. infrastructure and has crystalized the need for companies to be more exposed to the physical economy.SourceMoneyGuru-https://www.mgkx.com/5052.html
We believe firms that stand to benefit from the reshoring and infrastructure movement are not the digitally oriented mega-cap behemoths that have dominated markets over the past decade. Rather, we contend that the winners in this new regime could be the small- and mid-cap industrials stocks tied to the physical capital expenditure movement.SourceMoneyGuru-https://www.mgkx.com/5052.html
Wide valuation spread favors mid- and small-cap stocks.
Given the return disparity between mega- and large-cap stocks relative to mid- and small-cap stocks over the past several years, that’s exacerbated by the leadership of select massive tech companies, the valuation dispersion between the groups is at drastic extremes.SourceMoneyGuru-https://www.mgkx.com/5052.html
As of June 30, 2023, the Russell 2500™ Index (a good proxy for mid- and small-cap stocks) is trading at its largest discount in 15 years, from an enterprise value-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) perspective.SourceMoneyGuru-https://www.mgkx.com/5052.html
Because large caps have been the demonstrative leaders since 2010, many investors have been conditioned to believe their dominance will persist forever. However, this recency bias has caused many to forget that large caps went through a lost decade during the 2000s, generating a negative total return (-1.0%) while underperforming their smaller-cap counterparts by over 450 basis points (bps; 100 bps equal 1.00%).SourceMoneyGuru-https://www.mgkx.com/5052.html
The stock market is poised for continued growth in 2023, but investors should be aware of the risks associated with concentration and valuation in the mega-cap technology stocks. Mid- and small-cap stocks could be a good source of diversification and potential outperformance in this environment.SourceMoneyGuru-https://www.mgkx.com/5052.html
Investors should carefully consider their risk tolerance and investment objectives before making any investment decisions.SourceMoneyGuru-https://www.mgkx.com/5052.html SourceMoneyGuru-https://www.mgkx.com/5052.html