Some investors are wondering how long a few stocks can drive the market – and how to position portfolios.peterschreiber.media/iStockPhoto / Getty Images
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On the surface, the first half of 2024 has been strong for the markets, with many world stock indexes trading around record highs. But if you look a little closer, it’s clear that a small group of stocks are powering the market.
For much of the rebound since the bear market of 2022, the advance has been extremely narrow, with gains driven by the so-called “Magnificent Seven” U.S. technology companies – Nvidia Corp. NVDA-Q, Meta Platforms Inc. META-Q, Alphabet Inc. GOOGL-Q, Amazon.com Inc. AMZN-Q, Microsoft Corp. MSFT-Q, Apple Inc. AAPL-Q and, much less magnificent this year, Tesla Inc. TSLA-Q.
This year, the concentration has been more pronounced: even after a pullback, Nvidia on its own accounted for more than 40 per cent of the S&P 500′s year-to-date return as of June 24, according to Bloomberg data.
This phenomenon raises crucial questions for investors, such as how long the “narrow market” driven by a few stocks will last, whether these stocks are vulnerable to a correction, and how to position portfolios.
Lorne Steinberg, president of Lorne Steinberg Wealth Management in Montreal, says the large technology companies have experienced exceptional growth and have invested billions of dollars of excess cash into leading technologies such as artificial intelligence (AI), which he says is likely to be a “momentous game changer” in terms of the way businesses operate.
“The combination of such fast growth and share price appreciation has led investors to ride the momentum of these stocks while ignoring just about everything else,” he says.
In terms of whether investors should worry about the narrow market, Mr. Steinberg says they should always be concerned if their portfolio becomes too concentrated in a small group of “hot” stocks in a single sector while losing sight of valuations.
“When it seems like making money in the market is easy, that’s usually a sign that things may be getting overheated,” he says. “We have seen this movie many times before. The dot-coms could do no wrong in the late 1990s, and the oil stocks in the mid-2000s are but two recent examples. Investors should focus on owning stocks that represent great value, regardless if they’re in vogue.”
Mr. Steinberg says investors should be trimming technology stocks whose valuations have risen sharply and taking advantage of bargains elsewhere. He cites examples such as Starbucks Corp. SBUX-Q, Nike Inc. NKE-N, Walt Disney Co. DIS-N, CVS Group PLC CVSGF, Kraft Heinz Co. KHC-Q and Canadian banks.
“These stocks are out of favour, yet all of them are trading at attractive prices and offer growth at a very reasonable price,” he says.
Brianne Gardner points to macro effects as a key driver of the narrow market. The senior wealth manager with Velocity Investment Partners at Raymond James Ltd. in Vancouver notes that more global investment means more foreign money has poured into the Magnificent Seven stocks, as international investors want exposure.
“This extra demand has driven market cap and valuations to never-seen-before levels,” she says.
Like Mr. Steinberg, Ms. Gardner feels the AI boom is adding to the interest in these companies – and expectations for their increased profits. But she doesn’t believe investors need to be especially worried.
“These companies are profitable, growing businesses – yes, a tad expensive, but right now expectations are that they will continue to see profits grow for the near future,” she says. “Investors are piling into those stocks because they don’t see as much opportunity elsewhere.”
Nevertheless, Ms. Gardner warns against becoming overly reliant on a small number of stocks.
“Investors should have a diversified portfolio that can help smooth out returns and avoid concentration risk where your profits can disappear quickly,” she says.
Ms. Gardner notes that defensive stocks and fixed income – along with large-cap growth stocks such as tech companies – have historically performed best following the commencement of an interest rate-cutting cycle, so there’s a catalyst for other stocks to catch up.
Barry Schwartz, chief investment officer at Baskin Wealth Management in Toronto, notes the Magnificent Seven currently represent about 30 per cent of the S&P 500. While that may sound scary, he says it’s nothing new.
“There have been multiple times when the top 10 largest stocks in the U.S. were well over 30 per cent of the index,” he says.
“Novo Nordisk A/S is more than 60 per cent of the Denmark exchange. And, of course, many Canadians will remember – or probably hope to forget – that one stock, Nortel Networks Corp., was 35 per cent of the S&P/TSX Composite Index in 2000.”
Mr. Schwartz makes the case that the world has never seen companies like today’s tech giants before, with such extreme free cash flow generation, revenue growth, strong balance sheets, high margins and large runways for future opportunities.
Still, he cautions there’s no guarantee today’s winners will continue to outperform. “You may be overpaying for the future and that can be very risky,” he says.
His firm tries to limit client portfolios to no more than 8 per cent in any one stock. “You never know what can happen, and trimming winners – if we are so lucky to have them – keeps the risk of any one stock hurting us to a minimum.”
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