Tech Stocks Are Crushing the Market, but There’s a Sneaky (and Dangerous) Risk for S&P 500 Investors
Many market strategists have expressed concern about tech and artificial intelligence (AI) stocks, believing many of them are either overvalued or overearning amid an AI supercycle that may not be sustainable.
But investors who have owned large tech and AI stocks have likely done well in recent years. The Invesco QQQ Trust, which tracks the tech-heavy Nasdaq-100 index, is up 108% in the past five years, soundly outperforming the broader benchmark S&P 500 (SNPINDEX: ^GSPC) index’s nearly 78% rise in the same time frame.
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Although the S&P 500 is often considered safer than investing solely in tech stocks, there’s a sneaky — and potentially dangerous — risk investors should be aware of.
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The S&P 500 is intended to reflect the broader stock market. It’s a market-weighted index, so when companies in it grow, they receive more weight in the index.
In recent years, many large tech and AI names have surpassed a $1 trillion market cap or even become multitrillion-dollar companies. As such, they now account for a large share of the S&P 500. Here are the 10 largest names in the index by their respective weightings:
Nvidia — 7.8%
Apple — 6.9%
Microsoft — 5.6%
Amazon — 4.0%
Alphabet (Class A) — 3.1%
Alphabet (Class C) — 2.9%
Meta Platforms — 2.6%
Broadcom — 2.4%
Tesla — 2.1%
Micron Technology — 1.6%
Combined, these 10 names now make up about 39% of the S&P 500. Whether investors signed up for it or not, if they own the S&P 500, they have a much larger stake in big tech than in previous years.
In recent years, big tech became not only a growth play to capitalize on AI but also a flight-to-safety bet, with the belief that these companies were too systemically important and generated too much cash to ever face a serious threat.
However, many of them have now invested hundreds of billions in AI-related infrastructure, such as data centers, and several are now experiencing negative free cash flow. While AI looks like a total game changer, there’s still no guarantee that these huge capital investments will pay off.
The big risk is that if the AI trade softens, these stocks could get hammered, potentially taking the market with it. Previously, investing in the S&P 500 provided much more diversification for long-term investors.
So the market is heavily invested in the fate of big tech and AI. It’s a risk to be aware of when investing in the S&P 500, as the index is currently less diverse than it used to be.
It’s unclear how things will play out
Big tech accounts for nearly 40% of the S&P 500 and could be in for at least a reset, but there’s still no clear indication of what happens next. For instance, if investors funnel out of such stocks, it’s certainly possible they rotate into other S&P 500 names, leading to better breadth and evening things out in the overall index.
If that spending slows at some point, which investors think might happen, that could actually hurt the earnings of others in the broader market. But there are a few moves you can make.
If you are really worried about big tech and AI and don’t want exposure even within the S&P 500, you can purchase an equal-weighted S&P index fund such as Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP). This option removes the cap-based weighting of each stock. Keep in mind that while this index should be less volatile, it also likely won’t experience the same upside during bull markets.
Ultimately, long-term investors with at least a three- to five-year time horizon can stay invested in the S&P 500. But they should be prepared for volatility. It’s also likely best to practice dollar-cost averaging to smooth out their cost basis over time.
Should you buy stock in Invesco S&P 500 Equal Weight ETF right now?
Before you buy stock in Invesco S&P 500 Equal Weight ETF, consider this:
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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Broadcom, Meta Platforms, Micron Technology, Microsoft, Nvidia, and Tesla. The Motley Fool has a disclosure policy.
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