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The Citi U.S. Economic Surprise Index is heading straight south, dampening hopes for a broadening of S&P 500 performance leadership. The current trend suggests that even if we’re not in a technology bubble now, we might soon be.
The economic surprise index gauges U.S. economic data releases, weighted by importance, relative to consensus forecasts. The current reading of -45 indicates that the majority of vital data released recently have significantly undershot economist expectations, a potential sign of fading U.S. momentum.
A broadening of market leadership beyond the AI-related technology behemoths like Nvidia Corp., Alphabet and Microsoft Corp. will be, to some degree, a function of stronger economic growth. An accelerating economy means solid earnings growth becomes apparent beyond the megacaps benefitting from secular trends and global revenues.
Significant profit streams become available through smaller, more attractively valued stocks as the economy strengthens. Eventually, investor assets should gravitate away from existing, expensive market leading companies to own stocks representing decent earnings growth trading at more attractive valuations.
Wells Fargo strategist Christopher Harvey added more context to current trends by noting that full-year 2024 earnings expectations for small and midcap stocks have been falling but they are rising, if marginally, for the largest stocks. By sector, profits for technology and communications services are a growing share of total S&P 500 earnings while health care and energy are contributing less.
Mr. Harvey does not see a rotation away from the technology megacaps until U.S. economic growth bottoms out and the Federal Reserve starts cutting interest rates. The winners will keep winning in his estimation, increasing the odds of another 1990s-like tech bubble.
To mitigate risk, Mr. Harvey recommends a barbell approach. On one side, a 60 per cent allocation to communications services stocks that are trading at what he considers reasonable valuations and are enjoying strong price momentum (Alphabet and Meta Platforms are in this sector although not mentioned in the research report by name). On the other side of the barbell, a 10 per cent weighting in utilities and a 30 per cent position in health-care stocks provide downside protection.
— Scott Barlow, Globe and Mail market strategist
Also see: S&P 500′s tech dominance sparks calls for portfolio diversification
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