Index concentration and valuation risks are back in US equities Index concentration and valuation risks are back in US equities Index concentration and valuation risks are back in US equities

Index concentration and valuation risks are back in US equities

Peter Garnry

Chief Investment Strategist

Summary:  Concentration and valuation risks are coming back into US equities as May 2023 is ending today. The rally this year has been predominately driven by technology stocks and especially recently AI-related stocks. The narrowness of the rally and the fact that US equity valuations are back to levels not seen since July 2022 are elevating risks for investors and lowering future expected returns.


Key points in this equity note:

  • US equities have rallied this year on the back of exuberance in a narrow group of technology stocks and top 10 stocks in the S&P 500.

  • Concentration and valuation risks are reaching alarming levels, but could get worse if the AI hyped rally continues.

  • Equity valuations in the US are back to levels not seen since July 2022 and the current equity valuation suggests 10-year annualised real rate returns of -3% to +3% significantly below the long-term average of +5%

Concentration risks are never a good sign for the market

The total return in S&P 500 this year is 10.3% as of yesterday’s close, but the rally has been extremely unbalanced as we have written extensively about in this year’s equity notes. Just look at the best performing stocks this year. Starting with Apple as the biggest stock in S&P 500 with a market value of $2.79trn at the bottom of the performance table and moving upwards see total returns year-to-date of 37% or higher indicating the wild performance of not only technology companies but especially the largest stocks in the index such as Nvidia, Meta, Tesla, Amazon, Alphabet, Microsoft, and Apple. Concentration risk and narrow rallies in equities are often not good signs as they reflect a narrow theme played by the market and thus things can quickly turn around if the theme is sold off again. One potential catalyst could be a weaker than estimated US economy over the summer months.

Year-to-date returns | Source: Bloomberg

AI hype pushes US equity market back to dangerous equity valuation

The rally in US technology stocks this year, and in particular AI-related stocks, due to the market pricing in Fed rate cuts as the Fed will be forced to respond to lower economic growth, has pushed US equity market valuations to the highest level since July 2022. As we wrote in yesterday’s equity note, the global semiconductor industry has reached the highest equity valuations since early 2010 as growth expectations for semiconductors due to trends such as AI, electric vehicles and data center have fever levels. It almost feels like an echo from past bubbles.

Our combined equity valuation index on US equities reached 0.82 standard deviations above the historical average since 1992 up from 0.21 in September 2022. In other words, the US equity market never repriced below its long-term average underscoring the strong sentiment in US equities. If we look at what the current equity valuation means for future returns, based on past patterns, then we can see that the expected 10-year annualised real rate return is between -3% to +3% suggesting significant downside risks relative to the long-term average of +5% real rate return. Lofty equity valuations often goes hand in hand with overextended equity valuations in growth pockets of the market leading to subsequent outperformance of value stocks, which AQR co-founder Cliff Asness also recently predicted at the Morningstar Investment Conference.

Nvidia share price | Source: Bloomberg

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
The Circle 38
CH-8058
Zürich-Flughafen
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) Ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law. 

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.