Selective Momentum
“Companies that grow for the sake of growth…often stumble.”
Jamie Dimon
CEO, JPMorgan Chase
After a broadly strong start to the year, equity markets ended the second quarter of 2024 with mixed results as the tech-heavy NASDAQ outperformed the more diversified S&P 500 and DJIA indices by a wide margin (S&P 500 +4.3%; DJIA -1.3%; NASDAQ +8.1%).1
Even within the S&P 500—widely accepted as the barometer of the modern US stock market—just a handful of companies drove the bulk of the index’s gains in the first half of the year. Echoing trends that we wrote about last summer, the so-called “Magnificent Seven”2 have contributed some 60% of the S&P’s year-to-date total return, according to data from S&P Dow Jones Indices recently cited by the Wall Street Journal. These seven companies also trade at an average of 37 times their expected earnings over the next 12 months, a substantial premium to the overall S&P’s forward-looking P/E ratio of 21x (Figure 2).
Moreover, the Magnificent Seven’s recent run-up may be making the equity market look expensive as a whole. Using our price-to-economy (or P/Ec) ratio methodology as a guide, we can see that the value of the US stock market (proxied by the market capitalization of all stocks listed on the New York Stock Exchange) relative to the value of the US economy (proxied by Real Gross Domestic Product) has been treading on “overvalued” territory for some time, indicated by the P/Ec ratio (orange line) hovering at or above the historical upper bound (dark blue line) in Figure 3.
The spike in the P/Ec ratio at the far right of the chart above depicts a significant rise in the equity market’s value in the first quarter, consistent with the aforementioned performance (and corresponding jumps in valuation) among “tech giants.” As you can see, the P/Ec ratio has never been so high and prior peaks have often been followed by a prolonged pullback as the market “takes a breather.” In such circumstances, it may be prudent to re-examine equity allocations to ensure they still align with long term goals, as persistently higher stock prices can quietly push portfolios off course. Some reversion towards the mean with regard to valuations is also possible—while history shows market valuations steadily trending above prior norms, recent spikes may be less sustainable. Selectively taking gains now in the name of portfolio rebalancing could help reduce exposure to any future equity market volatility and potential downside.
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1 All index performance figures are total returns and include reinvested dividends.
2 The Magnificent Seven consist of tech and tech-adjacent heavyweights Nvidia, Microsoft, Apple, Amazon, Meta (formerly Facebook), Alphabet (formerly Google), and Tesla.