Big Seven Face Test on How Far Rally Can Run

Investors have had a lot thrown at them this year: more Federal Reserve tightening, a regional banking crisis, geopolitical turmoil. And yet US stock indexes are on track for a stellar year.

(Bloomberg) — Investors have had a lot thrown at them this year: more Federal Reserve tightening, a regional banking crisis, geopolitical turmoil. And yet US stock indexes are on track for a stellar year.

The reason, time after time, has been simple: Big Tech.

Worried about a recession? The seven largest tech-related companies have impregnable balance sheets and generate piles of cash in good times and bad. A spat with China? Not to worry, the likes of Alphabet Inc. and Meta Platforms Inc. benefit from ad sales all around the world. Growth back in favor? Nvidia Corp. and Tesla Inc. have it covered, from AI to EV.

Those four, along with Amazon.com Inc., Apple Inc. and Microsoft Corp., have been dominant in 2023. Investors have ridden the cohort to a nearly 40% gain in the Nasdaq 100 and a more than 16% rally in the broader S&P 500, overloading portfolios to the extent that warnings are again sounding: If everyone’s fully invested in megacap tech, where will the next impetus for more gains come from?

The question has taken on greater urgency with the S&P 500 basically flatlining since mid-July as investors digest the latest round of earnings and economic data while trying to gauge if the Fed is near pausing or pivoting interest rate hikes. Investors will get the latest clues on Wednesday from Chair Jerome Powell.

“It’s self-reinforcing, but there is for whatever reason a limit at which people go, ‘yeah, that’s enough,’” said Kim Forrest, founder and chief investment officer at Bokeh Capital Partners.

Momentum often wanes when retail investors get over a fear-of-missing out and rein in buying, she said. Net retail buying of AI-related stocks fell to the lowest since April last week, according to data from Vanda Research.

Investors on the bullish side are betting that the top stocks will continue to dominate in artificial intelligence, driving earnings growth even in an uncertain macroeconomic backdrop and potentially opening up new markets. The seven now account for about 28% of the S&P 500’s $37 trillion market value, up from about 20% at the start of the year.

Goldman Says AI Valuations Less Extreme, Disputing Bubble View

“That’s what some people are hoping on and maybe what these valuations are anticipating,” Brian Frank, portfolio manager of the Frank Value Fund, said. “It’s hard to bet against the innovation and technology.”

The run up has left many of the stocks expensive relative to history. Apple is priced at roughly 28 times projected profits, compared with an average of 18 over the past decade, according to data compiled by Bloomberg. Microsoft trades at about 30 times, about 25% above its average.

Zacks Investment Management is among those in a wait-and-see mode. The firm recently downgraded its outlook on shares of Apple to neutral, according to client portfolio manager Brian Mulberry. “We see a lot more sideways chop than anything” in the near term, he said.

There are some concerns that persistent inflation, a potentially weakening US consumer and other overhangs will cause the big tech stocks to lose some of their upward thrust.

“The Fed is trying to kill the momentum in not just these stocks but in any kind of speculative activity,” Frank said. “We see that these stocks aren’t bulletproof and once selling starts there can be some momentum to the downside.”

Tech Chart of the Day

The gap between Nvidia Corp.’s earnings multiples to the Philadelphia Semiconductor Index and the Nasdaq 100 Index has hit fresh lows. Its price relative to projected profits has fallen below 30 times, the lowest in a year. Nvidia’s eye-popping forecast last quarter drove earnings estimates higher while the rally in its shares has recently stalled.