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Thoughts From Last Week
Source: Standard & Poor's, FactSet J.P. Morgan Asset Management. Top 10 stocks include: AAPL, MSFT, AMZN, NVDA, GOOGL, BRK.B, GOOG, META, XOM, UNH, and TSLA. Data are as of August 11, 2023.
Investors should take advantage of historically wide valuation dispersion, and focus on low beta stocks characterized by stable cash flows and solid balance sheets.
As of last Friday’s market close, the top 10 stocks in the S&P 500 accounted for 90% of the index’s year-to-date gains. While market breath has been narrow and returns have been highly concentrated, the rally has broadened out relative to May, when the S&P 500’s 10 largest names accounted for all of the year-to-date gains. This decline in concentration can be attributed to surprisingly resilient economic data, which in turn has fueled better than expected profit growth and stock market performance. In fact, with the 2Q23 earnings season coming to a close, profits have surprised to the upside, with particular strength in the consumer sectors, construction, travel and streaming/gaming. With that being said, the recent broadening has been moderate at best, and mega-cap tech stock valuations remain stretched. The top 10 stocks currently account for over 30% of the index, which is down from the peak levels we saw in April/May but still extremely high relative to the last 25 years. Importantly, and in contrast to their weight in the index, the earnings contribution of these top 10 stocks is sitting near its pre-COVID level, but well below the pandemic era highs. Despite this misalignment in weights and earnings, the VIX has remained at historically low levels, which has been aided by the market becoming increasingly confident in a soft landing.
Whether this performance is sustainable hinges on inflation. Any further stickiness in core CPI may push the Fed to maintain a hawkish stance, thereby increasing the odds of a recession. In such a scenario, we would likely see earnings revised lower, leaving the market, where valuations are already stretched, particularly vulnerable. As such, investors should take advantage of historically wide valuation dispersion, and focus on low beta stocks characterized by stable cash flows and solid balance sheets.
Disclosure: Indices mentioned are unmanaged and cannot be invested into directly. The S&P 500 Index, or Standard & Poor's 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.