AI bonanza drives new highs and dangerous index concentration AI bonanza drives new highs and dangerous index concentration AI bonanza drives new highs and dangerous index concentration

AI bonanza drives new highs and dangerous index concentration

Equities 5 minutes to read
Peter Garnry

Head of Saxo Strats

Key points

  • AI-Driven equity surge: The recent AI boom, particularly driven by Nvidia's performance, has propelled US equities to new highs, significantly increasing the concentration of the S&P 500 in tech stocks like Microsoft, Nvidia, and Apple, which now comprise 20% of the index.

  • Market dynamics and sector performance: Real estate benefited from lower US bond yields, while the energy sector remains attractive despite a drop in crude oil prices. High index concentration may signal upcoming volatility, suggesting a shift towards active equity selection and small-cap stocks.

  • Upcoming economic indicators and earnings: Key upcoming events include the Fed's rate decision, US May CPI report, and major earnings releases, particularly from Broadcom, which is expected to show substantial revenue and EPS growth, influencing market expectations and investment strategies.


AI bonanza takes equities to new all-time highs

This week will be remembered for its big rally on Wednesday catapulting Nvidia to become the second largest stock in the S&P 500 and taking the US equity market to a new all-time high. As the our performance overview shows, all regions have gained this week and all sectors except for materials and energy have gained.

An interest rate sensitive sector such as real estate also had a good week as US bond yields headed lower on mixed US economic data points. In our view there is a lot of noise in the economic data points right now, but using the Dallas Fed Weekly Economic Indicators Index then the US economic growth has strengthened over the past 1-2 months.

The strong gains in equities came especially in semiconductor stocks and the S&P 500 Index concentration rose yet again to unprecedented levels with Microsoft, Nvidia, and Apple now accounting for 20% of the index and the 10 largest stocks have a combined weight of 35%. The US equity market has not been this concentrated in at least 50 years and it has consequences. First, it means that passively investing in US equities is now more than ever a bet on technology and a narrow set of stocks, Secondly, it means we are getting close to a pivot point in markets where active equity selection and stocks outside the mega caps will be the field of alpha in the future, in other words, we think investors should begin looking for small cap stocks. Historically, high index concentration has been followed by bursts of volatility so when the index concentration peaks investors should be prepared for higher volatility.

The energy sector is still the most attractive sector

A lower crude oil price this week on weak Chinese data and OPEC+ production decision is the main driver of the decline in the global energy sector. As our table of expected returns shows, the energy sector still has the highest expected real rate return driven by the dividend and buyback yield. Despite a comeback this week to real estate stocks the sector remains the least attractive.

CrowdStrike earnings showed why cyber security is still interesting

On Wednesday, CrowdStrike reported better than expected earnings results on both revenue and EPS, but more importantly the cyber security company raised its fiscal year guidance on revenue. The company’s single-platform strategy continues to be a competitive advantage for the company taking market share and capitalizing on an industry that is seeking alternatives to what Microsoft offers on cyber security and especially given a recent government report criticizing Microsoft’s cyber security culture. CrowdStrike shares rose 12% on the back of its earnings results.

CrowdStrike share price | Source: Saxo

Is ECB playing with fire?

The ECB delivered yesterday the most well-telegraphed interest rate cut in recent history, but it was not the beginning of the interest rate cut party that many had expected. We have argued multiple times that the ECB should have waited as the Eurozone economy was already rebounding. What was interesting was the rate cut seemed like something that the ECB had to do because of their forward guidance, but because of the recent data points it would probably have not done it. This is also why the ECB did not hint at any rate hike and instead referred to being data dependent. The market is still pricing that the ECB will cut again in October. As we have been saying for a while it seems odd that the ECB is so confident in its econometric forecasts on inflation when the Fed has been completely wrong on inflation. Our thinking is that the ECB is playing with fire. If they keep cutting the interest rate they might ease financial conditions for some parts of the economy but they risk increasing longer term inflation expectations.

Next week: Fed rate decision, US May CPI, Broadcom earnings

  • Fed rate decision: The market is pricing a low 21% probability for a rate cut at the FOMC rate decision on Wednesday. Data points since the last meeting are suggesting a resilient US economy and supercore inflation that has accelerated in recent month. The Fed is clearly confused after being wrong again on inflation. What the Fed and ECB are getting wrong might be that this economic cycle is income-driven and less credit-driven like in the past resembling more of what we saw in the 1950s and 1960s. If you want to familiarize yourself with this concept listen to this podcast featuring Bob Elliott from Unlimited Funds.

  • US May CPI: The most important macro figure in the coming week is the US May CPI report on Wednesday with economists expecting core CPI MoM of 0.3% vs. 0.3% in April. The worry in the April figures was that it was the sixth straight month of increase in the 6-month average of the MoM figures in the US core services CPI (excluding energy) suggesting that there are some inflation dynamics that are not well understood by the Fed. The US core services CPI was 6% annualised in April based on the previous 6-month data points which is clearly too high and inflation only looks moderate because of deflation in the goods economy which by and large is driven by China’s unsustainable and aggressive export policy.

  • Earnings: Key earnings to watch next week are Autodesk (Mon), Oracle (Tue), Broadcom (Wed), and Adobe (Thu). From an index weight perspective the most important earnings release is the one from Broadcom as the company is a global supplier semiconductors and infrastructure software used in data centres, networking, broadband, and wireless communications with Apple being one of its most important customers. Analysts expect Broadcom to report FY24 Q2 (ending 30 April) revenue growth of 38% YoY and EPS of $10.82 up 30% YoY.


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