Stock Market Downturn Possibility Due to Mega-cap Tech Stocks Surge

Stock market exhibits another Dot Com bubble-like signal

While the stock market has been performing exceptionally well, evidenced by the S&P 500 reaching a new all-time high of 5,200 after Federal Reserve Chairman Jerome Powell announced unchanged rates, concerns are beginning to surface. The latest concern underscores the discrepancy in performance between small-cap and mega-cap tech stocks.

Specifically, mega-cap tech stocks surpass small-cap stocks by the widest margin since the peak of the Dot Com bubble. This historical comparison harks back to 2000 when the Dot Com bubble burst, leading to the demise of numerous Dot Com startups that failed to achieve profitability despite burning through their venture capital.

Performance of the Nasdaq 100 Index from 2000 until today. Source: Barchart

There are more similarities to the previous downturns

JPMorgan Chase quantitative strategists have raised concerns about the growing dominance of the top 10 stocks in US equity markets, drawing parallels with the Dot Com bubble and warning of a potential sell-off.

By the end of December, the share of the top 10 stocks on the MSCI USA Index, including major tech players, reached 29.3%, just below the historical peak of 33.2% seen in June 2000. Additionally, only four sectors are represented in the top 10, compared to the historical median of six.

Stock concentration levels throughout history. Source: The Kobeissi Letter

The potential severity of the stock market downturn

While some may dismiss comparisons to the Dot Com bubble, the strategists argue that current circumstances bear striking similarities. They emphasize the risk posed by highly concentrated markets, where a downturn in the top 10 stocks could drag down the entire equity market.

Despite the strong performance of US stocks fueled by economic resilience and optimism about artificial intelligence, the valuation premium of the top 10 stocks relative to the rest of the index is higher now than during the Dot Com bubble.

This means that the potential downturn in the stock market could have consequences that haven’t been exhibited before.

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