Dear Friends,

I hope your weekend was a good one.

Investors have been tasked with interpreting a flurry of global economic data over the past couple of weeks. These include signals of resilient but moderating growth in North America, broadening economic weakness in Europe, and a stalled recovery in China. Meanwhile, the U.S. Federal Reserve raised interest rates by a quarter percent, as expected. Notably, the Fed indicated that it no longer foresees an impending recession. Additionally, some of the largest technology companies reported quarterly results that matched lofty expectations. We discuss the “tech” sector more below, focusing on its central role in propelling markets higher and the familiar challenge it poses to investors.

Moderating inflation, a robust economy, and enthusiasm for artificial intelligence have helped technology stocks regain their footing this year after a dismal 2022. The biggest gains have come from a select group of “mega cap” stocks. In fact, the seven largest stocks in the U.S. equity market can be categorized as “tech” companies, and their average value has nearly doubled this year. As a result, they have driven a good amount of the U.S. equity market, which is up nearly 18% year-to-date. When these stocks are excluded, the U.S. equity market has still posted gains, but at less than half that amount, which is more in-line with other regions.

The U.S. market’s reliance on a handful of the biggest companies is apparent. However, history suggests that this is not uncommon. Over the past century, there have been extended periods where the largest 5-10 stocks accounted for even greater proportions of the U.S. stock market. There have also been eras of sector concentration. The financial and transportation sectors dominated in the first half of the 19th century as the country was industrializing. In 1980, the energy sector comprised nearly 30% of the S&P 500 index at the peak of the energy crisis, a threshold that technology briefly surpassed during the dot-com bubble in 2000. The technology sector is hovering around these levels once again.

As risk managers, we are wary of a few challenges posed by the developments outlined above. Firstly, the U.S. market is undoubtedly more vulnerable to factors that impact the tech sector. Last year serves as a potent reminder, with the tech sector showing high sensitivity to rapidly rising inflation and interest rates, leading to broad equity market declines. Regulation, valuation, data privacy, and corporate governance are other factors impacting the sector, and consequently the wider market. Secondly, as stocks gain market weight, they correspondingly become larger weights in the portfolios that hold them. Our job is to ensure that our clients’ portfolio exposures are appropriate given their risk tolerances. As a result, we may rebalance positions that have appreciated.

Recently, there have been encouraging signs of broadening market strength. Other sectors and groups of stocks are appreciating in price, which is a healthy sign in our view. Should that trend continue, it may enhance the diversification of the market over time and help mitigate some of the risks mentioned above. In the meantime, we will be doing what we can to manage concentrations that arise and to maintain well diversified portfolios.

Should you have any questions or concerns, please feel free to reach out.

Have a great week.

Best Regards,

Frank