AI Giants Fuel S&P 500 Surge, Leaving Broader Market Behind

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The S&P 500 has surged by 17% this year, but this impressive performance can be attributed primarily to a small group of stocks, often referred to as the Magnificent Seven, which have capitalized on the AI boom. Nvidia, for instance, has driven over a third of the S&P 500’s gains. Meanwhile, the remaining 493 stocks in the index have experienced more modest earnings growth and shareholder returns.

According to a recent Bank of America report, these stocks have faced an earnings recession since early 2022. The S&P 493 hasn’t seen year-over-year earnings growth since the fourth quarter of 2022. The annual earnings dropped by 2% in the first quarter of 2023 and plummeted 7% in the second quarter. For the past three quarters, earnings growth has plateaued for this group.

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However, the second quarter of 2024 is anticipated to bring an end to this earnings recession for most S&P 500 companies. Forecasts suggest that earnings for these 493 non-Magnificent Seven stocks will grow annually by 6%, 7%, and 13% over the second, third, and fourth quarters of 2024. Despite this positive outlook, their growth will likely lag behind the overall index, heavily driven by the Technology and Communications Services sectors. These sectors include AI powerhouses like Nvidia, Microsoft, Meta, and Alphabet. Interestingly, the Health Care sector is also expected to see double-digit earnings growth, although this is largely due to one-time factors affecting companies like Pfizer and Merck.

Nvidia’s CEO Jensen Huang recently delivered a keynote at Computex 2024 in Taipei, underscoring the crucial role of Taiwan’s semiconductor industry in producing technology from iPhones to ChatGPT servers. This reflects the current market focus on the AI theme.

Wall Street has shown concern over the disparity between the AI-focused stocks and the broader market. The expectation was for a market rally to broaden out in 2024, but thus far, the AI theme continues to dominate. Over the last two quarters, the Technology sector has posted earnings growth of 25% and 27%, while Communications Services have reported gains of 53% and 43%. These robust figures explain their central role in market conversations and returns.

Given this environment, it’s sensible for strategists to question the usefulness of the S&P 500 as a benchmark. Piper Sandler’s Michael Kantrowitz noted the diminishing correlation between the index and its individual components, suggesting that the S&P 500 may no longer be the best representation of “the market.”

Despite this, investor frustration with the current market dynamic—where a few star performers overshadow the broader index—is likely to reach a peak. This could create an opportunity for investors to refocus on the undervalued stocks outside the AI-driven narrative.