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AI drives tech titan rally

This year's impressive surge in the stock market can be largely attributed to a select group of ten stocks. On a year-to-date basis, the widely tracked S&P 500 stock index experienced a 9.64 per cent increase until the end of May.

However, if we exclude these ten stocks from the index's composition, the overall performance was essentially flat.

Another metric to gauge the breadth of market participation is by comparing the returns of the S&P 500 market-weighted index with the S&P equal-weighted index.

Owing to the market capitalisation weighting methodology of the conventional index, larger companies have a significantly higher influence on the index's underlying value. During the first five months of this year, the equal-weighted index underperformed the market-weighted index by more than 9 per cent.

The primary winners of this year's market rally have been the mega-cap technology stocks, which we can perhaps call the Titan Ten. This group includes Apple, Microsoft, Nvidia, Alphabet (Google's parent company), Meta Platforms (formerly Facebook), Broadcom and Tesla. To be fair, these stocks performed poorly in 2022, so this year’s rebound may to some extent be considered a reversion to the mean.

However, the technology sector is being driven by a far more influential force. On February 15, I wrote about the rapid emergence of artificial intelligence and its potential to become mainstream — “AI comes of age as sci-fi meets real life”.

Since then, AI has not only become a dominant topic in the technology realm but has also begun generating big profits.

On May 24, semiconductor manufacturer Nvidia announced first-quarter earnings that surpassed analysts' expectations, coupled with a substantial upward adjustment in its forward revenue guidance.

This news led to a remarkable 24 per cent surge in Nvidia’s stock price, propelling the company to join the exclusive trillion-dollar club, reserved for companies with a market value exceeding a trillion dollars based on share price multiplied by shares outstanding.

Nvidia now ranks as the fourth-largest company in the S&P 500 in terms of market capitalisation.

Nvidia's aggressive investments in AI-focused chips have positioned it as a leading player in parallel processing and established the company as the poster child for AI. Meanwhile, increased investment in AI across multiple layers of the technology sector has benefited many other companies, including the Titan Ten.

Market technicians are an elite group of financial analysts who attempt to make sense of trends in market data to predict future price action. These technicians typically consider market breadth as a key variable.

For example, if the broad market index continues to rise while the number of advancing stocks declines, it could suggest a weakening rally with limited broad-based support. Conversely, increasing participation and strong breadth may indicate a healthy and sustainable direction.

However, it is worth noting that strong or weak market breadth alone has not consistently predicted future equity market returns. Historical examples have shown both market rallies and slumps after periods of narrow breadth. Therefore, investors need to also consider the fundamental underpinnings of the market and especially those stocks leading a rally.

Generally, investors prefer to see market breadth broaden, as it supports rallies in the equity market and provides opportunities for other stocks in the index to catch up. This suggests improving market internals and can be interpreted as a positive signal for the market as a whole.

Since the end of May, the equal-weighted S&P 500 index has slightly outperformed the market-weighted index by approximately 55 basis points. Additionally, the Russell 2000 index, representing small publicly traded US companies, has outperformed the S&P 500 by 170 basis points during this period. This movement suggests the potential for a broader rally.

Besides technical analysis, the fundamental aspect of our stock and index selection process involves considering the level of earnings revisions and surprises. In the case of Nvidia, its outstanding results and subsequent upward earnings revisions clearly point to underlying strength.

Conversely, Apple Inc, the world's largest company by market capitalisation, has witnessed a decline in consensus earnings forecast for the next 12 months since September, from $6.50 to approximately $6.00 per share.

We may therefore be at an important inflection point in terms of developing broader market participation. As we enter the summer months, an increase in market breadth, accompanied by better-than-expected fundamentals, would be regarded as a healthy sign. But we need to see fundamentals catch up with price.

The future trajectory of the market will depend heavily on the specific fundamentals of individual companies. In the large-cap growth sector, further monetisation of AI is required to justify the existing high valuations.

Undoubtedly, this wave of technological advancements will produce winners and losers, similar to the dotcom era of the late 1990s. During that time, contenders such as AltaVista, Yahoo and Netscape ultimately faded away, while companies such as Alphabet, Amazon and Meta, which were once fledgeling, emerged as major winners.

Bryan Dooley, CFA, is the chief investment officer at LOM Asset Management Ltd in Bermuda. Call LOM on 292-5000 or visit www.lom.com for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult their brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority

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Published June 27, 2023 at 7:58 am (Updated June 27, 2023 at 8:09 am)

AI drives tech titan rally

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