The market is currently seeing a significant trend of growth stocks outperforming value stocks within the S&P 500 index. Over the past two years, the S&P 500 Growth Index has surged by 57.3%, surpassing the overall S&P 500’s 41.6% rise and the S&P Value Index’s 23.8% gain. Despite this rapid ascent, only 40% of the stocks in the growth index have generated a positive return in the last month, raising questions about the sustainability of this growth.
The definitions of growth and value stocks play a significant role in understanding this trend. Companies that score high in sales growth, earnings change to price ratio, and momentum are categorized as growth stocks, while companies with strong book value, price-to-earnings ratio, and sales-to-price ratios fall under the value category. Investors have been drawn to growth stocks like Microsoft, Nvidia, and Apple, which have consistently grown their revenues and profits, leading to significant gains in their share prices and rising valuations.
The P/E ratio of the S&P 500 Growth Index has expanded to 34.9x, while the P/E of the S&P 500 Value Index has declined, indicating investors’ preference for growth stocks and willingness to pay higher valuations. However, the upward price momentum of the growth factor is primarily driven by a few mega-cap stocks. The largest 10% of companies in the S&P Growth Index, with market capitalizations surpassing $1 trillion, have led all the returns, while other deciles have experienced negative returns.
The dominance of mega-cap stocks like Microsoft, Nvidia, and Apple has been beneficial for index investors, as these companies continue to deliver on revenue and earnings projections. However, investors should be cautious and prepared for potential higher volatility in the market in case the AI boom subsides or the economy stalls, leading to a decrease in the premiums paid for large growth stocks. It is essential not to become complacent in the face of the current market trend, as the top companies driving the market higher today could easily reverse the trend in the future.
The current market scenario underscores the growing concentration levels across market-cap-weighted indices, with a small number of mega-cap stocks influencing market movements significantly. While this dominance has been positive for index investors thus far, it is crucial to remain vigilant and adapt to changing market conditions. As investors navigate through the dominance of mega-cap growth stocks, they should stay prepared for fluctuations and explore diversified investment strategies to mitigate risks associated with the high concentration of a few leading companies in the market.
