The S&P 500 has reached record highs this year, largely driven by the impressive performance of seven tech stocks. However, there are opportunities beyond the tech sector that deserve attention.
According to Dow Jones Market Data, as of the close of trading on Friday, the index has gained an astonishing $588 billion in market capitalization so far this year, bringing the total to an impressive $40.626 trillion. Incredibly, the combined gains from the seven tech giants—Tesla, Nvidia, Meta Platforms, Alphabet, Microsoft, Apple, and Amazon.com—accounted for $463 billion of that growth, leaving a mere $125 billion for the remaining 493 companies in the index.
Undoubtedly, Big Tech's remarkable run has contributed significantly to the S&P 500's 2% increase this year. Excluding this boost, driven by the promising prospects of artificial intelligence, the index would be relatively stagnant, hovering around the previous record set in January 2022.
The divergent performance between the S&P 500 and its equal-weighted counterpart offers valuable insights. The S&P 500 assigns weights to its constituent companies based on their market capitalizations, meaning that movements in behemoths like Apple and Microsoft disproportionately impact the index's overall direction. Conversely, the equal-weighted index reflects the collective movement of all stocks without bias towards market cap.
This year, the Invesco Equal Weight S&P 500 exchange-traded fund has experienced a slight dip in performance, while the S&P 500 has soared to record levels.
Consequently, the majority of stocks now trade at significantly lower valuations compared to both the S&P 500 and Big Tech. Based on FactSet's data, the equal-weighted index boasts a price-to-earnings ratio of 15.9 times analysts' expectations for aggregate earnings per share in the coming year. This valuation stands at a 20% discount when compared to the standard S&P 500's price-to-earnings ratio of 19.8 times.
In fact, this discount appears to be the most substantial observed in at least the past five years.
The continued progress of the economy, anticipated to stimulate earnings across various sectors, further enhances the allure of average stocks. While the Federal Reserve's implementation of 11 rate increases since March 2022 has slightly hampered growth, hiring activity remains robust, and wage growth has outpaced inflation in recent months. These developments bode well for the demand for goods and services, ultimately benefiting the average stock investor.
Economic Outlook Still Positive
Despite some challenges in the economy, certain sectors continue to experience solid growth year over year. The decline in inflation rates also indicates that the Federal Reserve may cut interest rates multiple times in the coming year. These rate cuts would inject more money into the market, enabling both consumers and businesses to increase their spending.
Positive Sales Forecast
According to FactSet, analysts anticipate a 4.7% annual sales increase for S&P 500 companies over the next three years. This projection takes into account various factors, including the moderation of inflation. Higher sales volumes would subsequently lead to improved profit margins, providing companies with additional cash flow to pursue stock buybacks.
Expected Rise in Earnings per Share (EPS)
FactSet's consensus suggests that EPS could see an annual rise of approximately 12% over the next three years. This positive projection reflects the expected effects of rate cuts and a more favorable spending environment for both companies and consumers. Young-Yu Ma, Chief Investment Officer at BMO Wealth Management, is optimistic about these developments, stating that investors are actively seeking investment opportunities beyond the tech sector.
Ordinary Stocks Could Outperform Mega-cap Tech
With a combination of growth potential and low valuations, ordinary stocks are poised for strong performance. According to Dennis DeBusschere of 22V Research, if concerns about growth and rate cuts diminish, non-Mega-cap Tech stocks could benefit significantly. While Big Tech may still have long-term growth potential due to its higher profits compared to average firms, temporary pullbacks in the sector could present better buying opportunities. It is advisable for investors to explore other sectors beyond tech, as the average stock may gain momentum soon.
In conclusion, despite ongoing economic challenges, the overall outlook remains positive. With anticipated rate cuts and increased consumer and business spending, various sectors are expected to experience growth. Moreover, the combination of rising sales volumes and favorable profit margins should provide companies with the necessary resources to pursue stock buybacks. As investors broaden their horizons beyond tech, ordinary stocks with attractive valuations may offer significant opportunities for growth.
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