The current bull market has presented a stark dichotomy for investors: there’s Nvidia and artificial intelligence (AI) stocks, and then there’s everything else. As we venture into the second half of the year, market participants are contemplating whether this divergence can sustain itself.
The excitement surrounding Nvidia, a pivotal player in the AI revolution, surged through the second quarter. The company’s sales and profit figures released in May exceeded Wall Street’s expectations for the fifth consecutive quarter. Consequently, Nvidia’s stock soared by 37% in Q2, bringing its year-to-date gain to an impressive 149%.
Conversely, the broader market has not shared this buoyancy. The average stock within the S&P 500 has risen by a modest 4.1% this year, while the index as a whole is up 14.5%, marking the largest disparity since at least 1990, as per Dow Jones Market Data. In fact, six of the eleven sectors within the index experienced declines in the second quarter, including financials, energy, and industrials.
This stark contrast has left many value investors exasperated. “We can’t keep up because we don’t own Nvidia,” remarked Max Wasserman, co-founder and senior portfolio manager at Miramar Capital. “If you don’t own that one stock, it really hurts. Every day feels like a root canal without novocaine.”
With the second half of the year on the horizon, investors are preparing for potential volatility. Many expect the Federal Reserve to cut interest rates by the end of 2024. Should this not occur, it could lead to market declines. Adding to the uncertainty are the upcoming presidential elections and potential shifts in government policies on taxes and energy. President Biden’s recent debate performance has added to the uncertainty, complicating the economic landscape further. Wall Street analysts remain optimistic about robust corporate earnings growth, though there’s a risk this optimism may not be realized.
Nvidia was the top performer in the S&P 500 last year and has more than tripled in value over the past 12 months, achieving a market value of $3 trillion in June, just months after surpassing the $2 trillion mark.
The so-called Magnificent Seven — Nvidia, Microsoft, Apple, Amazon, Meta Platforms, Alphabet, and Tesla — have been responsible for 60% of the S&P 500’s total return this year through Wednesday, according to S&P Dow Jones Indices. Investors are gravitating towards big tech stocks, drawn by their rapid earnings growth compared to the broader market.
“It makes sense to me that we are packed into a lot of these AI plays because that’s where people feel like there’s secular growth,” said Julie Biel, chief market strategist at Kayne Anderson Rudnick. “Even if you do a great job in the rest of the portfolio, if you’re not overweight in the same place, you’re just toast.”
Analysts predict that companies in the S&P 500’s information technology sector will see a 16% increase in earnings for the second quarter compared to the previous year, according to FactSet. Similarly, earnings in the communication services sector, which includes Alphabet and Meta, are expected to grow by 19%. In contrast, the overall earnings growth for the S&P 500 is projected to be less than 9%.
A cloudy economic outlook is one reason many stocks remain sluggish, Biel noted.
The blue-chip Dow Jones Industrial Average has gained 3.8% this year, while the Dow Jones Transportation Average, tracking 20 major U.S. companies in industries such as trucking and railroads, is down 3%. The Russell 2000 index of small and midsize companies has shown little change.
Persistent inflation has thwarted investors’ hopes for significant rate cuts this year. While the Federal Reserve has maintained steady interest rates thus far, many on Wall Street had anticipated up to six rate cuts at the start of the year. Recent slower price increases have revived hopes for potential rate cuts. The Fed’s preferred inflation measure remained unchanged in May from the previous month, according to the Commerce Department.
Despite Nvidia’s sharp rally evoking memories of the dot-com era, some investors argue that a market bubble isn’t forming this time around. “There’s been some differentiation from investors,” said James Hagerty, CEO of Bartlett Wealth Management. “Some stocks got hit very hard when earnings were very good but didn’t quite meet expectations.”
For instance, Nike shares fell 20% after the company reduced its revenue forecast, and chipmaker Micron saw a 7.2% decline following disappointing sales guidance.
The stocks within the Magnificent Seven trade at an average of 37 times their expected earnings over the next 12 months, according to FactSet, compared to the S&P 500’s average of 21 times.
Investors believe Nvidia’s rally can continue as long as it keeps exceeding sales and profit expectations. However, its high valuation leaves little room for error. “My guess is when Nvidia comes back to earth, it’s going to come back quickly,” predicted Brian James, managing partner and director of investments at Ullman Wealth Partners.
Key Takeaways:
- Nvidia’s impressive performance contrasts sharply with the broader market.
- The S&P 500’s gains are heavily driven by a handful of big tech stocks.
- Value investors are struggling to keep up without Nvidia in their portfolios.
- Economic and political uncertainties add to market volatility expectations.
- High valuations of tech stocks pose risks if earnings disappoint.
Conclusion:
As we advance into the latter half of the year, the stark divergence between Nvidia and the rest of the market raises critical questions for investors. While Nvidia’s AI-driven momentum has propelled it to new heights, broader economic and political uncertainties loom large. The market’s reliance on a few tech giants underscores the importance of strategic positioning and vigilance in navigating the evolving landscape.
