At the beginning of 2024, the seven largest stocks in the S&P 500 belonged to the tech sector (Apple
Apple
, Microsoft
Microsoft
, and Nvidia), communications sector (Meta and Alphabet) and discretionary sector (Amazon
Amazon
and Tesla
Tesla
).
The fact that a few of these stocks are among the largest isn’t a significant departure from the norm. Microsoft became the largest component of the index in 1999 and largely remained among the top three ever since, while by 2011 Apple was the second largest component. However, what stood out in 2023 was that all the gains in earnings per share (EPS) from the first through the fourth quarter were concentrated in those three sectors, according to Standard and Poor’s, while all others actually detracted from the S&P 500’s EPS growth. It seemed like nothing could go wrong for those three sectors, as the growth of operating margins and sales also surpassed all others.
According to Factset, analysts expect more of the same for the first-quarter earnings releases already underway, with five of those companies recording a strong 64% EPS growth and the other 495 showing a decline of 6%. With fundamentals being that strong, why were those leading stocks hit so hard last week?
The answer may lie in the expectation that the top five stocks’ contribution to EPS is set to shrink for the rest of the year, but expected to grow for the remaining 495. This is a big change: By year-end, the top-five stocks’ EPS growth is seen declining from 64% to just under 20%, but growing for the other 495 from that 6% contraction to more than 17% expansion.
Furthermore, first-quarter results for Meta, Alphabet and Microsoft are due later this week, along with Intel
Intel
, and investors may have decided to book massive gains on those stocks rather than risk a major earnings disappointment, or suffer an inflation-related setback when the Personal Consumption Expenditures price index, the Fed’s preferred inflation measure, is released on Friday.
Other hurdles to stock gains early this quarter were the somewhat disappointing CPI and PPI releases (Consumer and Producer Price Indices) and much stronger than expected retail sales. Before that, inflation had been perceived to be on a gradual path toward the Fed’s target of 2%, but in the wake of those numbers progress seemed stalled. Accordingly, the Fed continued to discourage the idea that cuts to interest rates were imminent. This caused the 10-year U.S. Treasury yield to rise by more than 40 basis points (almost half a percentage point) this quarter, which had a clear negative effect on stocks which fell in tandem with the rise in rates.
Meanwhile, the economy continues to show strength not only in retail sales but also in employment, home sales, and industrial production, all further supported by monetary aggregates that appear to be in early stages of expansion after a long period of contraction. A more comprehensive view of the economy will come this Thursday with the release of the first-quarter GDP estimate, rounding up a week unusually packed with important news for investors.
If earnings, revenues, and margins start growing across all stocks instead of being confined to the top few, the long-awaited shift out of mega-caps and into the rest of the market may be gaining momentum in the upcoming quarters. To be sure, this has had many false starts but, if history is any guide, it seems inevitable. Choosing an equal-weight version of the S&P 500 index like RSP
Invesco S&P 500 Equal Weight ETF
rather than a cap-weighted version like SPY
SPDR S&P 500 ETF Trust
seems to be a good way to express that view, especially since the gap between both grew considerably since about a year ago and is now close to its widest level.
