US stocks have been incredibly resilient this year. In the midst of a banking crisis, historically high interest rates, geopolitical turmoil and heightened recession forecasts, the S&P 500 is up nearly 7% year-to-date. But investors should be wary, warn analysts, because the churn under the surface shows noticeable weakness.
The rally that the S&P 500 has enjoyed since the beginning of the year has been driven by a small group of stocks — the market cap of the remaining 480 or so has basically remained the same.
"This is not a broad-based rally where all stocks go up but instead a rally concentrated in a few of the largest stocks by market cap, mainly tech names," Torsten Slok, chief economist at Apollo Global Management, told CNN.
Leading the way in growth are tech stocks like Apple, Microsoft, Alphabet, Amazon, Tesla and Meta.
The collapse of Silicon Valley Bank and stabilizing inflation rates have led to speculation that The Federal Reserve's painful interest rate hikes could soon come to an end.
That's been a boon to large cap tech stocks that are more sensitive to interest rates because they tend to borrow more than established companies and rely more on the prospect of future earnings.
But it also means that the current market rally is thin, as the major indexes outperform the average stock.
Nvidia, Berkshire Hathaway, Visa, Exxon Mobil, UnitedHealth Group, Johnson & Johnson, Walmart, JPMorgan Chase, Procter & Gamble, Mastercard, Eli Lilly & Co, Chevron and Home Depot rounded out the list of the stocks driving the vast majority of growth in the S&P 500.
"The implication for investors is that this market is not driven by broad-based higher growth expectations but instead by what has happened with rates, in particular after [Silicon Valley Bank] went under," said Slok.
Strong outperformance from the largest stocks often power indexes to rise, said Liz Ann Sonders, chief investment strategist at Schwab, in a note Tuesday. But healthy markets should be characterized by greater participation of the "soldiers" — the rest of the stocks, she said.
The flight to big tech is also a reaction to an increase in fear and uncertainty by traders, said Patrick Kaser, portfolio manager from Brandywine Global. Market moves this year have come with a "huge undercurrent of skepticism," Kaser told CNN. As the climate grows more unstable, investors are falling back on the large cap companies that they've come to rely on over the past few years.
"In these initial stages of uncertainty people do tend to go back to what worked in the last cycle," he said. "That's not necessarily a guarantee that those stocks will continue to grow, but it is that comfort food they want to go back to, the Teslas and the other stocks that made easy money in the past."
The tech sector was a popular safe haven for traders during the height of the pandemic. In 2021, the combined yearly revenue of Amazon, Apple, Alphabet, Microsoft and Facebook (now Meta) was $1.2 trillion — 25% higher than it was pre-Covid.
The bottom line: The market looks really expensive based on traditional valuation metrics, said Kaser. "We've had this weird pause over the last three weeks where analysts haven't been updating earnings estimates because of the banking turmoil. Those are undoubtedly going to come," he said.
"There's currently a false sense of security that things won't change, but a lot of the data under the surface is probably pointing towards higher odds of recession. This is not a favorable starting point for stocks as we think about the next few months."
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