A recent article in the Wall Street Journal (WSJ) argues that investors outside of big tech have concerns and that this fear is hidden by the dominance of big tech stocks. The WSJ article titled Big Tech Companies Unplug Stock Market From Reality was published on Tuesday, June 4. The article argues that while the S&P 500 (SPX) seems to be holding its own, the strength of the indexes masks a deeper concern – big tech is skewing measures used by “macro” investors who focus on the economy and the Fed.
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The Big Tech Factor
The S&P 500, often used as a barometer for the overall market, has been heavily influenced by the performance of big tech stocks. Companies like Nvidia (NASDAQ:NVDA), Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL), and Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG) have propelled the index higher this year, with their market capitalizations dominating the standard, value-weighted index. This has led to a situation where the average stock in the S&P 500 is more affected by rising yields than at any time this century, while the big tech-dominated index appears less affected.
Valuation and Sensitivity to Interest Rates
The valuation of the market, when divided into deciles by company size, shows a clear trend. The valuation rises steadily as company size increases, with the median stock in the S&P trading at 18 times forward earnings versus more than 21 times for the big tech-dominated index. This suggests that while the market as a whole may not be cheap, the Big Tech stocks are trading at a premium.
The sensitivity to interest rates is also split. The ordinary S&P 500, which gives more weight to larger companies, has a weaker link to Treasury yields than the equal-weighted version, which treats tiddlers the same as titans. This unprecedented split in the link to bond yields is indicative of the divide between the Big Tech stocks and the rest of the market.
Cash Piles and Interest Rates
The Big Tech companies sit on huge cash piles, which insulates them from the effects of rising interest rates. Smaller companies, on the other hand, are more sensitive to interest rates as they have less cash and may need to issue bonds to boost liquidity. This has led to a situation where the smallest companies in the market are almost as cheap, at a median of 15 times forward earnings, as the index as a whole was at the lowest point of the COVID-19 panic in 2020.
Key Takeaway – Significant Divide Between Big Tech and the Rest
The WSJ warning comes at a time when the big tech stocks continue to perform well. It points out that investors outside this sector are right to worry about the prospect of higher rates. Today’s high valuation of the S&P is hiding the fact that its smallest companies are almost as cheap as the index was at the trough of the COVID-19 selloff in 2020. This suggests that while the overall market may appear strong, there is a significant divide between the big tech stocks and the rest of the market.
