© Reuters. FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., May 22, 2023. REUTERS/Brendan McDermid
By Lewis Krauskopf
NEW YORK (Reuters) – As the U.S. stock market continues its ascent, investors holding shares of the huge leading technology and growth companies are wondering whether to cash in or stay put.
A record $8.5 billion has been poured into tech stocks in the past week, data from BofA Global Research shows, as investors piled into a rally that saw heavy tech gain 33% in 2023. The benchmark is up 11.5% this year and is at a 10-month high.
Still, others see reason for caution. Among them is the narrowness of the market rally: the five largest stocks in the S&P 500 have a combined weighting of 24.7% in the index, a record dating back to 1972, Ned Davis Research said in a recent report. The heavy weightings could mean bigger spillovers for broader markets if these names falter.
“We’ve had this big run and the key question is, do you think it’s going to continue or do you think things are going to go back to average?” said Peter Tuz, president of Chase Investment Counsel.
Excitement over advances in artificial intelligence is a key factor fueling gains in megacap stocks. Big movers include shares of Nvidia (NASDAQ:), which are up around 170% this year, while Apple (NASDAQ:) and Microsoft (NASDAQ:), the two largest US companies by market value, have both climbed nearly 40%.
Jay Hatfield, CEO of hedge fund InfraCap, believes enthusiasm for AI will continue to boost megacap stocks. He’s overweight megacaps, including Nvidia, Microsoft and Google-parent Alphabet (NASDAQ:).
“We believe 100% in the AI boom,” Hatfield said. “I would be shocked if by the end of the year those stocks weren’t significantly higher.”
Friday’s data showed U.S. job growth accelerating in May, even as a jump in the jobless rate suggested labor market conditions were easing, boosting appetite for investors for equities in the hope that the Federal Reserve will be able to reduce inflation without seriously hurting growth. The S&P 500 rose 1.45%.
Megacap shares have dominated the markets for much of the decade since the financial crisis and betting against them has been a perilous strategy in 2023. Investor allocation to cash is higher than it has been historically, according to BofA data, which some market watchers say leaves plenty of fuel to push the rally further.
Strong momentum may also continue to propel stocks higher.
Michael Purves, CEO of Tallbacken Capital Advisors, wrote earlier this week that technical analysis showed the Nasdaq 100 is overbought, a condition that can make an asset more vulnerable to steep declines. However, the index managed to gain another 10% over three months after reaching the same state two years ago, according to Purves.
Nvidia’s recent surge showed how a stock can continue to climb even after posting big gains. Shares were already up 109% ahead of its May 24 earnings report, but rose another 30% last week after the chipmaker’s surprisingly upbeat sales forecast.
Kevin Mahn, chief investment officer at Hennion & Walsh Asset Management, said Nvidia shares, which now trade at 44 times forward earnings estimates, according to Refinitiv Datastream, have gotten “a bit rich.”
“I still like the tech sector over the next two years, but now I have to focus a lot more on valuation given the rise of many of these megacap stocks,” said Mahn, who asserts that Microsoft shares remain attractive in part due to the company’s impressive cash flow and strong dividend yield.
Others are increasingly wary, citing factors such as rising valuations and signs that the rest of the market is languishing as a small group of stocks soar.
The performance of just seven stocks, Apple, Microsoft, Alphabet, Amazon (NASDAQ:), Nvdia, Meta Platforms and Tesla (NASDAQ:), accounted for the entire S&P 500 total return in 2023 through May, indices show. S&P Dow Jones.
Meanwhile, just 20.3% of S&P 500 stocks outperformed the index on a rolling three-month basis, a record dating back five decades, according to Ned Davis. Levels below 30% preceded a weaker performance for the broader market, with the S&P 500 rising 4.4% over the next year against an average of 8.2% for all periods of a year, according to the company’s research.
David Kotok, chief investment officer at Cumberland Advisors, has in recent days reduced holdings of semiconductor ETF iShares following the latest spike in Nvidia shares.
Kotok sees the narrowing in magnitude as a bad sign for the broader stock market, saying stocks also look less favorable in some asset valuation metrics.
In a commonly used valuation measure, the S&P 500 is trading at 18.5 times forward earnings estimates compared to its historical average of 15.6 times, according to Refinitiv Datastream.
“You can have (market) concentration and it can last for a while,” he said. But, he said, “to me, the shrinkage is a warning.”