US equities have pleasantly surprised this year.
Large-cap stocks in the US have shown impressive performance in 2024, particularly with the S&P 500 rising by nearly 15% since the beginning of the year (*as of 6/24/24). The S&P 500’s rise owes much to Nvidia (NVDA), pushing the index to record highs. However, this surge masks a more nuanced reality. While Nvidia has been a powerhouse, many other constituents have stagnated since the beginning of 2022. In fact, over half of all stocks in the S&P 500 have witnessed declines in value during this period, underscoring a tale of two markets within the same index. Being that the S&P 500 is a market-capitalization weighted index, larger companies will have more effect on the performance of the underlying index. Examining the S&P 500 equal weight index, where each company’s contribution to the index’s performance is equal, shows that the S&P 500 has only risen by 7%.
Nvidia alone has contributed a staggering 44% to the S&P 500’s gain since the beginning of 2022. This lopsided reliance on a single company poses a significant risk, especially considering the broader market’s exposure to Nvidia’s fortunes and the overarching uncertainties in Artificial Intelligence-related sectors. Investors who typically consider S&P 500 ETFs as a diversified investment option now find themselves disproportionately tied to Nvidia and the inherent risks of investing in an emerging sector such as technology. While this strategy has generated significant profits thus far, it has also compromised the index’s risk diversification. This growing dependency on a single sector raises concerns about potential market fluctuations and the long-term sustainability of such concentrated holdings. This idea was conceptualized in our previous newsletter, which discusses the risks associated with concentrated positions in a single investment security.
Top Contributors and Detractors to S&P 500 Performance (01/2022-05/2024)
Should Nvidia encounter headwinds, the hope is that other sectors might compensate. Stocks outside the tech giants might offer a lifeline, yet Nvidia’s substantial market influence could drag down the entire market should it falter, a scenario evident in recent market reactions to its fluctuations. These reactions were evident on June 24th when Nvidia dropped 6%, pulling the tech-heavy Nasdaq down by over 1%, even though many tech firms did not experience such steep declines individually. Nvidia’s share decline was primarily due to profit-taking and expiring options, and the shares have since rebounded from that price drop.
The current dilemma is further compounded by uncertainties surrounding economic growth and the Federal Reserve’s stance on interest rates. Bond yields have declined, but hopes for prompt rate cuts have dimmed, as Fed officials await clearer signs of inflation control before taking action. And despite recently lower bond yields, smaller stocks in the S&P 500 and the Russell 2000, sensitive to interest rate changes, have failed to rally, signaling a lack of confidence in economic prospects absent significant rate adjustments.
Conversely, the latest projections from the European Central Bank indicate that the euro zone’s economy will grow by 0.9% in 2024. Meanwhile, a real-time estimate from the Federal Reserve Bank of Atlanta suggests that America’s economy is currently expanding at over three times that rate. China is grappling with a property crisis and the threat of deflation, Japan is defending its weak currency, and Britain is struggling with poor productivity. A combination of robust growth and a strong dollar is causing America’s share of global GDP to rise. This trend could lead to the continued ascent of the S&P 500.
In the midst of Nvidia’s spectacular rise and broader economic unease, prudent investors may want to temper enthusiasm and assess the sustainability of this narrow rally. Diversification remains a key strategy, extending beyond the S&P 500 into diverse asset classes like bonds, international equities, and alternative investments such as real estate or commodities. Employing a diversified approach to investment management can mitigate exposure to individual company or sector risks, providing a more resilient investment portfolio in an uncertain market landscape.