Today’s Big Tech-dominated stock market has shades of dot-com bubble, strategists warn

Today’s Big Tech-dominated stock market has shades of dot-com bubble, strategists warn

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By José Adinolfi

A team of quantitative strategists at JP Morgan sees shades of the dot-com bubble in the stock market rally that has taken the S&P 500 to six all-time highs since early 2024.

According to the team of analysts led by Khuram Chaudhry, the ever-increasing concentration in the US stock market has become a major risk that investors should be aware of in 2024. Although there are several important differences between the bubble era of dotcom and current affairs, Chaudhry and his team insist that the two periods are more similar than one might initially expect.

“When viewed in historical context, parallels with the ‘dotcom bubble’ era are often dismissed due to the ‘irrational exuberance’ that characterized this period. In this note, we demonstrate that there are a host of similarities.” between these two periods.” Chaudhry and his team wrote in a note seen by MarketWatch on Tuesday.

The analysis comes at a time when the lopsided nature of stock market returns over the past year has largely favored stocks of the largest U.S.-listed companies, a group that has earned the nickname “the seven magnificents”.

These stocks drove most of the S&P 500’s 24.2% gain last year, according to FactSet, and have continued to outperform since early 2024. As a result, concentration in the U.S. market is nearing its highest level. high since 2000.

That is, the top five stocks now represent 21.7% of the MSCI USA XX:984000 index at the end of 2023, according to JP Morgan figures, while the share of the top ten, which includes the Magnificent Seven, has increased up to 29.3%. For the top five, this level is 0.7 percentage points away from the post-1994 peak of 22.4% recorded in March 2000.

The current top 10 is moderately further below its all-time high share of 33.2%, which occurred in June 2000. Still, by both measures, the concentration is the highest since the dot-com days.

The MSCI USA index has 609 stocks and is intended to measure the performance of large- and mid-cap stocks traded in the United States, according to an MSCI fact sheet on the index.

In its analysis, the JP Morgan team focused on several factors. For example, they determined that the number of sectors represented among the 10 most valuable companies is actually less diverse in 2024 than during the peak of the dot-com bubble.

Back then, there were six sectors represented among the top 10 stocks, compared to just four today. What’s more, they found that during both periods, IT companies accounted for the majority of the group’s total market capitalization.

Meanwhile, valuations mark another important difference between the dot-com era and today. During the dot-com era, JP Morgan strategists found that the forward price-earnings ratio of the 10 largest companies in the US market peaked at 41.2 times expected earnings. Currently, the top 10 is valued at 26.8x.

But the JP Morgan team highlighted an important caveat. They took the reciprocal of the forward price-to-earnings ratio, a metric known as forward earnings yield, and measured the spread between the top 10 stocks in the MSCI USA index and the rest of the index.

What they found is that as recently as October, the top 10 stocks in the index had the largest earnings premium relative to the rest of the index on record, although the premium has since narrowed considerably.

Meanwhile, JP Morgan strategists found that the proportion of overall earnings-per-share growth contributed by the 10 largest stocks was actually higher during the dot-com days, helping to refute the conventional wisdom around that period, during which stocks had become completely disconnected from fundamentals.

“While we would hesitate to refer to the current levels of the Top 10 as a bubble, it would certainly appear that the Top 10 in the Dotcom era was supported by superior earnings performance,” the JP Morgan team said.

Finally, the strategists measured the difference in price returns between the top 10 stocks and the rest of the US index. They found that, generally speaking, periods of strong outperformance are often followed by episodes of mean reversion.

This would suggest that Big Tech is behind in a period where it lags the broader market, as happened in 2022. Wary of the chances of a Big Tech-led sell-off, the JP Morgan team warned its clients They “expect stock market declines to materialize, which may well be due to weakness in the Top 10.”

Most Magnificent Seven stocks were trading lower on Tuesday: shares of Nvidia Corp. (NVDA) and Tesla Inc. (TSLA) were steady, shares of Microsoft Corp. (MSFT) and Alphabet Inc. ( GOOGL) fell less than 1%. and shares of Apple Inc. (AAPL) and Amazon.com Inc. (AMZN) fell sharply. Shares of Meta Platforms Inc. (META) were the only member of the group to trade higher on the day.

Weakness among big tech names contributed to a 0.7% drop in the Nasdaq Composite COMP to 15,525. Meanwhile, the S&P 500 SPX was down 0.1% at 4,924, still within striking distance of its most recent all-time closing high.

-Jose Adinolfi

This content was created by MarketWatch, operated by Dow Jones & Co. MarketWatch is published independently of Dow Jones Newswires and The Wall Street Journal.

 

(END) Dow Jones News

01-30-24 1535ET

Copyright (c) 2024 Dow Jones & Company, Inc.

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