After briefly being crowned king of the stock market, Nvidia is hit hard. While that might be a wake-up call to investors who worry that this year’s rally may rely too much on a few big tech names, there are plenty of ways to avoid bubble-shaped prices while still largely remaining invested.
Last Tuesday, Nvidia briefly overtook Microsoft to become the world’s most valuable company. Since then, investors have turned on the maker of artificial intelligence chips, sending its shares down nearly 13% over the past three trading days.
Nvidia’s woes aren’t just a potential problem for AI evangelists. Nvidia and other members of the so-called Magnificent Seven tech stock club are responsible for much of the market’s overall gains in recent years. Technology stocks now have a weighting of around a third in the
S&P500,
compared to less than 25% in 2019.
Nvidia’s valuation (it trades at around 70 times earnings) suggests the stock could fall further. Even though the price-to-earnings ratios of other tech names that dominate the market aren’t as extreme, these stocks are also highly valued. The actions that make up the
Technology Select Sector SPDR
Exchange-traded funds trade at 29 times earnings, according to Morningstar, well above the 21 times for the broader market.
For investors, the combination of large index weightings and high valuations poses risk. If traders were to suddenly turn sour on big tech stocks, that sector’s weakness alone could be enough to trigger a bear market, notes Jim Paulsen, an independent Wall Street researcher.
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“The infamous Mag7 (and perhaps a handful of other notables) have seen their prices rise dramatically and if they collapse – due to their outsized weightings – the S&P 500 Index could suffer a drop of more than 20%,” he writes.
Fortunately, Paulsen notes, the top-heavy nature of the market contains a glimmer of hope. While Nvidia and other top tech stocks have advanced, many segments of the market, including materials, industrials and consumer discretionary stocks, have been left behind. They have achieved average annual returns of between 5 and 10% over the past few years.
“Typically, when the S&P 500 is extended and overbought, most stocks in the index have enjoyed significant bull market participation and the S&P shows widespread vulnerability to a bear market,” Paulsen writes. “In the contemporary bull market, however, the concentration has been so intense that most stocks have not participated excessively, making the bear market’s task much more difficult. »
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Today’s price/earnings numbers reflect that dynamic, giving investors wary of valuations like Nvidia’s plenty of opportunities to bet on the stock market without getting caught in the froth. Take a look at the Invesco S&P 500 Equal Weight ETF, which holds a roughly equal amount of all stocks in the index, rather than matching stock weightings to their market values, as the S&P 500 does .
The fund’s allocation to tech stocks is a significant, but not overwhelming, 16%. His portfolio trades at 18 times earnings, a hair below the long-term market average of 19.
Another approach is small-company stocks, which have lagged large-cap stocks eight times over the past decade. THE
iShares Russell 2000 ETF
is even cheaper: the shares it owns trade on average at just 15 times earnings.
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To be sure, betting on underperforming stocks means investors risk missing out on some of big tech’s AI-fueled momentum. But when sentiment changes, the market is much less likely to punish stocks whose prices seem easily justified by their quarterly earnings.
This could save investors from major difficulties.
Write to Ian Salisbury at ian.salisbury@barrons.com
News Source : www.barrons.com
Gn bussni
