Investors have been tasked with interpreting a flurry of global economic data over the past two weeks, including signals of resilient but moderating growth in North America, broadening economic weakness in Europe, and a stalled recovery in China. On July 26^th, the U.S. Federal Reserve raised interest rates by 0.25%, 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 this sector 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. 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 substantial amount of the S&P 500 index, which is up nearly 18% year-to-date. When these stocks are excluded, the market has still posted gains, but at a clip of about 7%, which is more in-line with other regions.

 

History reflects that the U.S. market’s reliance on a handful of the biggest companies is not an uncommon occurrence. 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 movements. There have also been eras of sector concentration. The financial and transportation sectors dominated during the first half of the 19^th 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 near 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 (the Nasdaq declined by over 30%). Regulation, valuation, data privacy and corporate governance are other factors impacting the sector, and consequently the wider market. In addition, 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. Should this 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 manage concentrations that arise with a view to maintaining well-diversified portfolios.

 

If you have any questions, please do not hesitate to contact us.