The Federal Reserve has disappointed investors this year, but no matter. The markets have adjusted.
Even without any interest rate cuts so far in 2024 — and with the likelihood of just one meager rate reduction by the end of the year — the stock market has been purring along. That’s quite an achievement, given the expectation in January that the Fed would trim rates six or seven times in 2024 — and that interest rates throughout the economy would be much lower by now.
Buoyant as the stock market may seem, when you look closely, it’s apparent that the S&P 500’s recent returns rest on a precarious base.
A.I. fever — based on the belief that artificial intelligence is ushering in a new technological age — has been spreading among investors, and that has been enough so far to keep the overall stock market averages rising. But the rest of the market has been rather ho-hum. In fact, strip away the biggest companies, especially the tech companies, and overall market performance is unimpressive.
Concentrated Returns
One stock in particular has led the market upward: Nvidia, which makes the chips and other associated infrastructure behind the talking, image-generating, software-writing A.I. apps that have captured the popular imagination. Over the last 12 months, Nvidia’s shares have soared more than 200 percent, vaulting its total market value above $3 trillion, which places it in elite territory shared only with Microsoft and Apple in the U.S. market.
But the narrowness of the stock market rally becomes clear when you compare the standard S&P 500 stock index with a version that contains the same stocks but is less top-heavy.
First, consider that the standard S&P 500 is what is known as a capitalization-weighted index — meaning $3 trillion stocks like Microsoft, Apple and Nvidia have the greatest weight. So when these giants rise 10 percent, say, they pull up the entire index much more than a 10 percent gain by a smaller company in the index, like News Corp, with a market cap of around $16 billion, can.
The standard cap-weighted S&P 500 has risen almost 14 percent this year — a spectacular gain in less than six months. But there is an equal-weighted version of the S&P 500, too, in which 10 percent gains — for giants like Microsoft and merely large companies like News Corp — have the same effect. The equal-weighted S&P 500 has gained only about 4 percent this year. Similarly, the Dow Jones industrial average, which isn’t cap-weighted (it has plenty of its own idiosyncrasies, which I won’t get into here), is up only about 3 percent.
A Premium on Size
In short, bigger is better in the stock market these days. A recent study by Bespoke Investment Group, an independent financial market research firm, demonstrates this. Bespoke broke down the S&P 500 into 10 groups, based solely on market cap. It found that the group containing the biggest companies was the only one to have positive returns over the 12 months through June 7. At the same time, the group with the smallest stocks in the index had the biggest losses.
This pattern held true when Bespoke looked only at A.I. companies. Giants like Nvidia had the strongest returns. Smaller companies generally lagged behind.
During just this calendar year, stock indexes tracking the largest companies are trouncing those that follow small-cap stocks: The S&P 100, which contains the biggest stocks in the S&P 500, is up about 17 percent. The Russell 2000, which tracks the small-cap universe, is up about 1.5 percent for the year.
Even among technology stocks, the bull market isn’t treating all companies equally. Ned Davis Research, another financial market research firm, said in a report on Thursday that while companies that design, manufacture or make equipment for chips (a.k.a. semiconductors) in the S&P 500 are performing splendidly, all other technology sectors have lagged the index this year.
Implications for Investors
While I pay close attention to these developments, I try not to care about them as an investor. In fact, I view the concentration of the current market as a vindication of my long-term strategy, which is to use low-cost, broadly diversified index funds to hold a piece of the entire stock and bond markets. The overall market’s dependence on a small cohort of big companies is fine with me, but that’s only because I’m well diversified. So I don’t worry much about which part of the market is strong and which isn’t.
As far as my own portfolio is concerned, I’m…
Read More: Why the Stock Market Has Risen Even With No Fed Rate Cuts