Longer-term, there’s something deeper going on: The Magnificent 7 growth stocks — which have always commanded much higher multiples than the typical S&P 500 company — have been accumulating greater and greater weighting on the index. The septet of Alphabet Inc, Amazon.com Inc, Apple Inc, Meta Platforms, Microsoft Corp, Nvidia Corp and Tesla Inc now account for about 29% of the S&P 500 by market cap (vs. 17% in 2019 and 14% in 2017), explaining a lot of the valuation drift to close to 20 times forward earnings from a 2017-2019 average of about 17.
The S&P 500 Index hit an all-time high on Jan 19, punctuating its 38% return from the trough in October 2022. Much of the exciting rally has reflected an expansion of forward price-earnings ratios, and there’s a broad sense that management needs to start putting up the profits to justify current valuations. I suspect that corporations — and seven in particular — are up to the challenge.
The run-up in valuations over the past few months has been driven by a decline in government bond yields, which — among other things — boosts the relative attractiveness of equities in the eyes of investors. That tailwind has faded with markets having front-run the Federal Reserve’s expected policy rate cuts this year.
