• Investors are clearly bullish.
• 7 companies drives the S&P 500 to new highs.
• Reminiscence of Tech Bubble 2.0

The bulls are back

Optimism among market participants appears to have re-captured the stock market once again.

Despite the challenges faced in recent months, such as the surge in inflation, equity markets have managed to overlook concerns of a recession and interest rate scares. The US stock market has displayed impressive resilience, even amid recent difficulties like the banking crisis that triggered panic in the sector. Not only is the US economy growing, but its primary indicator, the S&P 500, has surpassed its pre-hiking levels of March 16th, 2022. This suggests a resurgence of bullish sentiment among investors.

New bull market

S&P 500 entered a bull market this month, up over 20% since the October lows of last year. Since the 1920s, bull markets have lasted for 1011 days on average, roughly three times longer than bear markets over the same period. Additionally, over the last century, bull market returns were substantially higher, producing a 114% return on average, compared to a -25% return during bear markets. Unsurprisingly, as a result, investors who bet on the US economy’s success win in the long run.

Is this time different?

However, this bull market might be different. It is no secret that seven big tech-heavy hitters are fuelling this rally and carrying the S&P 500 index up.

The performance of the S&P 500 index is now the most concentrated it has been since the covid-19 days. Seven of the biggest constituents — Apple, Microsoft, Google owner Alphabet, Amazon, Nvidia, Tesla, and Meta or the “Magnificent Seven” have surged between 40 percent and 180 percent this year, in contrast to the remaining 493 companies, whose aggregate performance is essentially flat.

Tech dominance in recent months has become mind-blowing; just 5 of those tech companies account for 25% of the market cap of the entire index. Apple, for instance, at nearly $3 trillion, not only has the largest weight in the S&P 500 but is worth more than the combined value of all the 2000 companies in the entire Russell 2000 index!

Nividia is another example of bubbly valuation. The company gained over $640B in market cap this year, as investors’ enthusiasm about AI has propelled $NVDA through the $1 trillion market cap threshold.

However, underneath the surface, as investors pile into a handful of stocks, this is masking some broader market weakness. The overconcentration has caused some serious valuation worries. Prices seem to be racing ahead of future earnings, making multiple valuations detached from reality. Look at how the “Big 7” Price to earnings is north of eye-water 30, while the rest S&P 500 hovers around 15. And if we zoom in at those seven tech giants, we will see even more distortions. Nvidia has Price to sales = 40, while the rest, except for Microsoft, are trading below 10, as the AI mania leads to market dislocations.

On top of that, that craze for stock might have fuelled a fear of missing out (FOMO) rally among equity traders, further exacerbating the valuation metrics distortion.

In essence, the big tech titans are carrying this market, along with rate cuts hopes. The latter might not happen this year, as interest rate traders have priced out lower Fed rates.

This looks very reminiscent of a tech 2.0 bubble. There is a lot of noise in the markets, but one thing is clear valuations are mean reverting. Hence, the question is not if but when they will come down to earth.