Stock market concentration: Interpreting the tech stock rally

Portfolio Insights

Jul 11, 2023

The bottom line

Seven technology stocks drove the bulk of S&P 500 Index returns in the first half of 2023.
A concentrated rally doesn’t have to be a bearish sign – especially when the rest of the market starts catching up.
Opportunities for active stock pickers abound, but consider holding onto your broad index exposure as well to aim at capturing unexpected run-ups for your clients.

Missing a rally is a bummer, technically speaking.

U.S. stock indexes have gotten off to a great start in 2023. But given the shape of the rally – with the bulk of performance concentrated in just a handful of stocks – many investors may have missed it.

In the first half of the year, 70% of the performance of the S&P 500 Index was driven by just seven technology stocks. In a bullish sign for stocks, this calculation accounts for some easing in stock market concentration over the past few weeks. When we had looked at this year-to-date calculation on June 6^th, the top seven had driven over 100% of the index’s performance. (The S&P 500 Index return for that period would have been negative without those seven stocks.)

Stock performance has been highly concentrated in 2023

Source: Bloomberg, as of 6/30/23. The top seven stocks ranked by performance contribution include: AAPL, MSFT, NVDA, AMZN, TSLA, META and GOOG/GOOGL.

Ironically, the mega-cap technology stocks that led the rally were among those that most forecasters had expected to have a very hard year due to higher interest rates making bets on future growth expensive. The near future did not look bright for the tech sector and many investors shied away early in the year.

However, economic data has indicated that a recession may not be as soon or as deep as initially feared, and technology stocks have performed remarkably well. Even as markets have priced in high interest rates through the end of the year, the super stars in tech have continued their ascent amid a growing enthusiasm for artificial intelligence-related themes. Investors who were underweight technology missed out.

Take a fresh look at stocks today

Investors are now left with many questions. Is it too late to get a piece of the action in the big tech names? Is the AI theme creating a price bubble that’s bound to burst? And what about the rest of the market? Has the stock rally peaked?

Rich Mathieson, portfolio manager of the BlackRock Global Equity Market Neutral Fund, believes the AI trade still has room to run, and he shares a few reasons to be optimistic about market performance from here:

The technology sector today is very different from that of the dot-com era of the late 1990s. The concentration of returns within the technology sector was a lot higher when the bubble burst in 2000. Additionally, we see a stronger fundamental backdrop for tech companies today, particularly in terms of cash flow generation and profitability.
Artificial intelligence is not necessarily a speculative play. A handful of the leading players are already monetizing the opportunity and making upward revisions to near-term earnings estimates. This is keeping valuations in check at levels which, albeit elevated, are comparable to those observed in recent history.
Gains on the S&P 500 Index in June have been broader across sectors. Additionally, much of the equity market is trading at valuations near, and in some cases, below recession levels, providing a decent runway for continued broadening of market performance, particularly if the economy can be spared a hard landing.

Our Global Allocation Selects and Multi-Asset Income models both rebalanced recently (on 6/21 and 6/27, respectively), and both increased their allocations to U.S. equities, suggesting that there may indeed still be room for this rally to run.

Key takeaways for your portfolio

1. Don’t be spooked by index valuations. When the price-to-earnings ratio on the S&P 500 Index hovers around 20, it is reasonable to suggest that stocks look expensive. However, when you exclude the seven top-performing stocks, the index P/E ratio drops to a much more reasonable and historically average 17.5.

Most stocks are not as pricey as the index

Price-to-earnings ratios on the S&P 500 Index with and without the seven top-performing stocks of 2023

Source: FactSet forward P/E as of 6/30/23. “Ex top 7 stocks” excludes AAPL, MSFT, AMZN, GOOG/GOOGL, NVDA. TSLA, META.

2. Know your portfolio gaps. There are always surprises in the markets and drifting too far away from market exposures can cause you to miss out, especially if you make a big call that turns out to be wrong. Regularly analyze your portfolio to identify missing exposures and assess the risk of maintaining those gaps versus filling them.

3. Build in core index exposure alongside active stock picking strategies. Stock market dispersion creates opportunities for active stock pickers. As we’ve seen this year, getting stock calls right can pay off in a big way, and missing them can be painful. Combine your high-conviction active bets with broad market exposure in the core of your portfolio.

Are you ready for the next big thing?

This is not the first time the S&P 500 has been driven by a few high-flying names, and it won’t be the last. Portfolios with broad index exposure may be able to capture any potential additional run-up in the big tech names and whatever the next big thing may be.

BlackRock can help you construct well-diversified portfolios for your clients. Contact your BlackRock representative or explore our online investment tools and resources.