The recent surge in bond yields has sent shockwaves through the U.S. stock market, with concerns arising about the vulnerability of highly-valued shares in mega-cap technology and growth companies. Seven behemoth stocks, including Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta Platforms, have been the driving force behind the stock market’s gains this year. As of now, these seven companies account for more than 80% of the S&P 500’s total return for 2023.
Investors have long seen these stocks as significant beneficiaries of advancements in artificial intelligence (AI). Earlier in the year, the financial sector faced turbulence due to regional banking issues, and investors sought refuge in mega-cap stocks with strong balance sheets and stable business models.
However, the soaring stock prices have inflated valuations, causing some investors to worry that mega-cap stocks could be susceptible to further declines if rising bond yields continue to weigh on the stock market. The “Magnificent Seven” stocks trade at an average price-to-earnings (P/E) ratio of 31.8 based on earnings estimates for the next 12 months, a stark contrast to the S&P 500’s P/E ratio of 18.1.
Given their collective weight of 27% in the S&P 500, any weakness in mega-cap stocks could exacerbate the broader index’s decline, which has already retreated 6.6% from its July highs. However, the S&P 500 is still up more than 11% year-to-date.
“When the big tech stocks start going down … the indexes go down,” noted Matt Maley, Chief Market Strategist at Miller Tabak. This decline can trigger a snowball effect as investors become nervous and begin selling their mutual funds or exchange-traded funds (ETFs), further depressing the market.
The recent stock market selloff has already impacted some mega-cap stocks, with Apple, the largest company by market value, dropping approximately 13% since late July. Nvidia, another high-flying stock, fell by nearly 12% in September. Despite these setbacks, Apple remains up 32% for the year, while Nvidia has surged nearly 200%.
The pressure on mega-cap stocks is emanating from rising bond yields. Higher yields on Treasuries offer investors an alternative to stocks and increase borrowing costs for both corporations and households. The yield on the U.S. benchmark 10-year Treasury has reached its highest level in roughly 16 years, largely due to concerns that the Federal Reserve may maintain interest rates at current levels for an extended period.
Tech and growth companies, including mega-caps, tend to be particularly sensitive to rising yields because their future projected earnings are discounted more severely. Matt Stucky, Senior Portfolio Manager at Northwestern Mutual Wealth Management Co., noted, “Because (the mega-caps) are more highly valued, that just means that they are going to be more sensitive to changes in real interest rates.”
Options markets are also reflecting elevated concerns among investors. Thirty-day implied volatility for the Nasdaq-100-tracking Invesco QQQ ETF, which measures expected short-term price swings, has recently surged to 22, the highest level since mid-April.
However, some strategists emphasize that the rise in implied volatility for tech stocks is not significantly higher than that of the broader market. Nevertheless, this complacency could leave tech stocks exposed to increased volatility if market declines accelerate from current levels.
Despite the overall market’s decline, some mega-cap stocks have managed to hold up relatively well. Alphabet, for example, has seen only a slight drop in its shares since late July.
The Nasdaq 100, which serves as a proxy for a broader range of large tech and growth stocks, has experienced a similar decline to the S&P 500 since late July. It remains up around 35% for the year but has retreated 7% from its highs.
Beyond the impact of rising yields, mega-cap stocks face other risks. Amazon, one of the major players among these companies, is grappling with a U.S. antitrust lawsuit filed against it, adding a new layer of concern to the mega-cap space.
Moreover, while optimism surrounding the increased use of AI applications has bolstered tech stocks this year, there are lingering questions about the extent to which AI will ultimately boost profits. J. Bryant Evans, Portfolio Manager at Cozad Asset Management, noted, “The whole promise of AI hasn’t… reached fruition yet.” This uncertainty underscores the challenges mega-cap tech companies face in maintaining their lofty valuations and growth trajectories amid evolving market dynamics.
