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The Growing Dependence on Megacap Stocks Raises Concerns


A recent report from JPMorgan Chase & Co. highlights the increasing reliance of the U.S. stock market on a small group of megacap names, which could potentially lead to trouble ahead. The team of equity analysts, led by Marko Kolanovic, JPMorgan’s Chief Global Markets Strategist, suggests that historically, periods characterized by heavy favoritism towards a select few ultra-valuable stocks have not ended well.

According to FactSet data, the current level of concentration in the market is growing at a rate not seen since the 1960s, surpassing even the levels witnessed during the dot-com bubble in March 2000. To illustrate this point, the JPMorgan team compared the six-month change in the index weighting of the ten largest stocks in the S&P 500 with the next 40 stocks. This analysis revealed a significant divergence, with the largest companies outpacing the rest of the market.

Interestingly, the crowding in growth stocks included in the S&P 500 has now reached levels comparable to those during the dot-com bubble. This observation is based on historical data and implies that current conditions could be unsustainable.

While the report provides ample data and analysis to support concerns regarding overconcentration, it offers limited insight into how this might impact the market. The JPMorgan team suggests that a sell-off is likely to occur but does not specify the timing. They mention various possibilities, such as a severe recession or a sudden resurgence of inflationary pressures, as potential catalysts for a market correction.

In conclusion, it appears that the growing dependence on a small number of megacap stocks raises concerns about the stability of the market. While it is difficult to predict precisely when a sell-off will occur, it is widely agreed that the current frenzied focus on these stocks is unlikely to be sustainable in the long term.

Diminishing Interest in Generative AI

In a recent note, the JPMorgan team mentioned that the peak interest in generative AI and large-language models may soon fade as investors become more rational after the initial frenzy. As this theme loses momentum, it could alleviate the concentration risk associated with megacap technology stocks like Apple Inc., Microsoft Corp., Nvidia Corp., and Alphabet Inc. These stocks have been the primary beneficiaries of the AI boom.

Special Rebalancing of Nasdaq-100

The team also addressed the special rebalancing of the Nasdaq-100 that took place on Monday. This rebalancing has the potential to help reduce the concentration risk further. By easing the outperformance of megacap tech stocks, such as Apple, Microsoft, Nvidia, and Alphabet, this rebalancing aims to add more balance to the market.

Notable Changes to Nasdaq-100

To get a clearer picture of the changes resulting from the special rebalancing, here are four significant alterations made to the Nasdaq-100 index.

Investors who want to take advantage of this perspective can bet on call options tied to the S&P 500 equal-weighted index. The JPMorgan team recommends betting that these call options will outperform calls tied to the S&P 500 by 2.5% over the next three or six months.

Easing Overconcentration Problem

There are already signs that the overconcentration problem highlighted by JPMorgan is beginning to ease. Over the past month, data from FactSet shows that the S&P 500 equal-weighted index has outperformed its market-cap weighted counterpart by 2 percentage points.

Market Performance

On Monday, U.S. stocks finished higher, with the Dow Jones Industrial Average booking its longest winning streak in nearly six years. While megacap tech stocks have experienced a torrid rally throughout the year, market laggards like the value-heavy Dow are starting to pick up again. The S&P 500 and Nasdaq Composite also performed well, with gains of 0.4% and 0.2% respectively.

Note: This content is for informational purposes only and should not be construed as investment advice.

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