When it comes to the stock market rally, everything isn't as it seems. | Image: Bryan R. Smith / AFP
- Five mega-cap stocks have created the illusion of a fast and complete recovery in the U.S. stock market.
- If we remove the impact of FAAMG stocks, the S&P 500 would be down for the year.
- A decline in FAAMG share prices would bring the whole market down.
You shouldn’t believe the hype around a stock market recovery, even if the S&P 500 has soared by more than 50% from its March low. Here’s why.
Five Mega-Cap Stocks Are Fueling The S&P 500 Rally
The five FAAMG stocks have fueled the stock market rally–that is, Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), and Google-parent Alphabet (NASDAQ:GOOGL).
The FAAMG stocks are the five largest constituents of the S&P 500. The market cap of these companies now represent 23% of the index’s market cap, a new record high . This is considerable weigh means the performance of only five stocks is driving the whole market.
The strong performance of the FAAMG stocks has pushed the S&P 500 to new highs, as they have returned 35% year-to-date together. They are all up more than 20% this year. If we remove those five stocks, the S&P 500 would still be down 5% for the year.
If we look at the S&P 500 on an equal-weighted basis rather than a cap-weighted basis, we see that if it wasn’t for the five mega-caps, the S&P 500 is roughly flat from its March lows.
The FAAMG companies have been aggressively repurchasing their shares, which has helped drive their share prices higher. The COVID-19 pandemic is a significant factor in tech stocks dominance, as investors see a paradigm shift in the way businesses operate.
More work-from-home environments and an increase in e-commerce mean businesses will need to invest more heavily in their technology infrastructure to accommodate a remote workforce. Physical stores will have to adapt to the realities of e-commerce or disappear in the process.
The Tech Stocks Rally Could End Soon
While FAAMG stocks could still see their shares go higher, it’s reasonable to expect that these companies’ growth could taper in the months ahead. That means their share prices will eventually experience a healthy pullback. They are trading at historically high P/E ratios relative to their averages.
The hype towards tech stocks could fade when a vaccine becomes available. As the S&P 500 is heavily concentrated in tech stocks, it appears wiser to not just own the index and diversify in other sectors that will benefit from the recovery, such as airlines and hotel stocks.
Jim Cramer says investors should expose their portfolios to both lockdown and recovery plays. Watch the video below:
If FAAMG stocks start to crash, it will bring down the whole market.
Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com. The writer owns shares of Microsoft.
