Megacap technology stocks have dominated the U.S. stock market performance this year, powering the Nasdaq Composite to a new nine-month high this week as investors have loaded up on them in a \u201csafe-haven play\u201d on concerns over a potential recession, a federal debt-ceiling breach and more stress in regional banks. <\/p>\n
The tech-focused Nasdaq-100 index Meanwhile, the Nasdaq Composite Shares of America\u2019s tech behemoths have been buoyant so far in 2023. Apple Inc. See: <\/strong>A stock-market milestone: Apple is now worth more than the entire Russell 2000<\/p>\n MarketWatch spoke with analysts to explore what factors have resulted in technology stocks being the dominant force in the U.S. equity market in 2023, and what drawbacks they could have this year. <\/p>\n First, investors were very cautious with low expectations for the tech sector coming into 2023 after the bear market of 2022, which is \u201ca good starting point for a group to outperform when there are skeptics that give you a chance to prove them wrong,\u201d said John Porter, chief investment officer and head of equity at Newton Investment Management.\u00a0<\/p>\n The Nasdaq Composite slumped nearly 33% in 2022 as the high-growth nature of stocks in the tech-heavy index left them particularly vulnerable to the rise in interest rates engineered by the Federal Reserve to combat inflation. <\/p>\n \u201cThey\u2019re considered growth stocks, and people are willing to pay a higher valuation as they\u2019re expected to grow,\u201d said Mike Dickson, head of research and product development at Horizon Investments. \u201cLooking backwards on a year-over-year basis, they actually haven\u2019t been growing, but from an expectation standpoint, it does appear that right now is probably the trough for earnings unless we get very bad growth prospects going forward.\u201d\u00a0<\/p>\n Megacap results in this past quarterly earnings reporting season seem to be taken as confirmation that the sector can continue delivering strong growth, given their rock-solid balance sheets, strong cash-flow generation and robust profit margins.\u00a0<\/p>\n \u201cThey are large companies with well-diversified revenue bases, with no debt, with profitable income statements, with strong balance sheets,\u201d said Olivier d\u2019Assier, head of APAC applied research at Qontigo, in a phone interview on Friday. \u201cEven though they [investors] are betting on tech, they\u2019re betting on the conservative of the safe segment of tech. They [megatech] can weather the storm.\u201d<\/p>\n Porter said he has seen a new wave of \u201ccost discipline\u201d in some high-profile tech companies. Their control of costs is translated into faster-than-expected earnings improvement, making their balance sheets and revenue streams more appealing to investors compared with other types of stocks, said Porter.<\/p>\n Among 95% of S&P 500 companies which reported results in the first quarter of 2023, 78% of them have reported a positive earnings-per-share surprise, which is above the 5-year average of 77%, said John Butters, senior earnings analyst at FactSet.\u00a0<\/p>\n Signs that U.S. inflation is starting to moderate and the Federal Reserve is nearing the end of its interest rate hiking cycle also contributed to the tech leadership, said market analysts.\u00a0<\/p>\n Fed Chair Jerome Powell on Friday said his colleagues think that it will take some time to bring inflation back to the central bank\u2019s 2% target, while confirming that the Fed has not yet decided what to do at its June 13-14 FOMC meeting. Dallas Fed President Lorie Logan said Thursday that the data points so far don\u2019t justify skipping a rate hike in June.<\/p>\n Fed-funds futures traders Friday saw a 16.8% chance of another quarter-of-a-percentage-point rate hike by the central bank in June, according to CME FedWatch tool.\u00a0<\/p>\n Still, the most significant driver of megacap tech\u2019s outperformance over the last six or eight weeks has been artificial intelligence (AI), Porter told MarketWatch in a phone interview on Friday.\u00a0 <\/p>\n \u201cWe\u2019re in a hype cycle here around AI, which has created a halo around a lot of key stocks in the tech sector, and that\u2019s been sort of the icing on the cake,\u201d Porter said.\u00a0<\/p>\n For example, investors have flocked into Nvidia Corp. Meanwhile, Microsoft Corp. There is a pretty high probability that investors are going to see a \u201csignificant boom of AI profits and growth,\u201d said David Russell, vice president of market intelligence at TradeStation. \u201cWe have new business, new products, which means higher margins and better pricing. We\u2019re entering where the market is moving away from cloud-computing, cloud migration, and e-commerce \u2026 it [AI] is a game changer.\u201d<\/p>\n See:<\/strong> AI is a \u2018baby bubble\u2019\u2026for now, but a Fed \u2018mistake\u2019 could pop it, says Bank of America<\/p>\n However, Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management, said tech stocks are \u201cextremely overvalued\u201d as even a company like Microsoft, was trading at price-to-earnings ratio of 33 in late April, which \u201cseems a little pricey to us for a company that isn\u2019t even growing its earnings by one third of its multiple,\u201d he wrote in emailed comments.\u00a0<\/p>\n \u201cWe don\u2019t mind paying for growth but overpaying for small growth doesn\u2019t excite us,\u201d he said.\u00a0<\/p>\n Big tech remains a large weighting in the S&P 500 index with Apple, Microsoft, Amazon.com \u201cAs a result, many investors have become increasingly worried about the potential effects that this top-heavy concentration could have on market performance, especially if these names begin to stumble,\u201d Belski wrote in a Thursday note.\u00a0<\/p>\n However, Belski and his team admit this concentration is not necessarily detrimental for performance. The chart below shows that performance breadth tends to increase in the six and 12 months after peaks in market cap concentration, as highlighted by the uptick in the percentage of outperforming stocks and uptrends in relative price of the S&P 500 Equal-Weighted index Performance breadth usually indicates the number of stocks advancing relative to those that are declining in a certain stock index. An increasing market breadth occurs when more stocks are rising than are declining.\u00a0<\/p>\n
\n NDX,
\n
\n which tracks the top 100 non-financial companies listed on the Nasdaq exchange, on Thursday ended at its highest level since April 2022. The index rose 3.5% this week and has advanced more than 26% year-to-date, according to FactSet Data.<\/p>\n
\n COMP,
\n
\n gained over 3% on a weekly basis. The tech-heavy gauge has risen 20.9% so far in 2023, according to FactSet Data. That compares with a 9.2% year-over-year gain for the broader S&P 500 index
\n SPX,
\n
\n and a merely 0.8% increase for the Dow Jones Industrial Average
\n DJIA,
\n
\n \u00a0<\/p>\n
\n AAPL,
\n
\n stocks have risen nearly 35% this year, putting its market capitalization surpassing that of the entire Russell 2000
\n RUT,
\n
\n for two weeks, the longest stretch on record, according to Bloomberg data shared with MarketWatch. Meta Platforms Inc.
\n META,
\n
\n has jumped 104.1% year-to-date and Google\u2019s parent, Alphabet Inc.,
\n GOOGL,
\n
\n has advanced 39.1% over the same period, according to FactSet Data.<\/p>\nA reversion of the 2022 trades<\/strong><\/h4>\n
Strong balance sheet and durable revenue streams<\/h4>\n
A potential end to Fed rate hikes<\/strong><\/h4>\n
Big Tech\u2019s AI craze<\/strong><\/h4>\n
\n NVDA,
\n
\n this year, putting the chip maker\u2019s stock up 113.9% so far in 2023. Jensen Huang, Nvidia\u2019s founder and chief executive predicted revenue from artificial-intelligence platforms will grow significantly in the next 12 months as businesses either climb on board with AI or get left behind.\u00a0<\/p>\n
\n MSFT,
\n
\n has seen its stock surge by 32.7% this year and AI provider C3.ai
\n AI,
\n
\n has exploded 125.9% over the same period, according to FactSet Data.<\/p>\nIs megacap tech overvalued?<\/h4>\n
\n AMZN,
\n
\n NVIDIA, and Alphabet now making up more than 20% of the large-cap index. The current aggregate weight represents a notable increase from the 17% at the start of the year and is slowly beginning to approach the record level of 22.3% set in 2020, said BMO Capital Market\u2019s strategists led by Brian G. Belski, chief investment strategist. <\/p>\n
\n SP500EW,
\n
\n \u00a0<\/p>\n