A small group of tech stocks is driving the market rally — why that's 'not a flaw'

This year's stock market rally has been led by just a few large tech names.

While it might seem concerning to have too much riding on a handful of stocks, strategists say the trend may not be a bad thing for markets.

"We see a small group of tech winners leading stock gains as a feature of the artificial intelligence (AI) theme — not a flaw," Jean Boivin, head of BlackRock Investment Institute, wrote in a research note on Monday. "We stay overweight U.S. stocks."

AI darling Nvidia (NVDA) has accounted for nearly one-third of the S&P 500's gains this year, and outperformance in quarterly results from large-cap tech continues to be a reason why earnings for the S&P 500 are growing year over year.

As of Monday's close, Apple (AAPL), Alphabet (GOOG, GOOGL), Microsoft (MSFT), Amazon (AMZN), Meta (META), and Broadcom (AVGO) had also contributed more than a quarter of the major index's gains.

One potential concern is that the market could be at risk if a few large tech companies that have driven a lion's share of the gains stop surprising to the upside.

However, research from Morgan Stanley's chief investment officer, Mike Wilson, shows this might not be an issue.

Wilson found roughly 20% of the top 500 stocks are outperforming the broader index over a rolling one-month period. This is the lowest percentage of companies outperforming in Wilson's dataset dating back to 1965.

Wilson's work noted that after similar narrow breadth readings where less than 35% of companies are outperforming the index on a one-month basis, the S&P 500 rose about 4% on average over the next six months.

"Narrow breadth can persist but it's not necessarily a headwind to forward returns in and of itself," Wilson said. "We believe broadening is likely to be limited to high quality/large cap pockets for now."

Wilson argued that when considering the impact of high interest rates on corporations, this makes sense. Investors have flooded large-market-cap stocks that have held up well in the higher rate environment and are seeing earnings grow more than their smaller peers.

And a slew of recent upgrades to year-end S&P 500 targets reflect similar sentiment. Three Wall Street firms cited tech outperformance as part of the reason the index is doing better than they initially thought this year.

Evercore ISI's Julian Emanuel boosted his target to 6,000 from 4,750, citing the "early innings of AI" and a market supported by the "persistence of AI exuberance." Citi's Scott Chronert bumped his year-end target to 5,600 from 5,100 noting "the weighting effect of the mega cap growth cohort is exerting an outsized influence on index price action."

Goldman Sachs' equity strategy team boosted its year-end target to 5,600 from 5,200, highlighting that increasing earnings expectations for Alphabet, Microsoft, Amazon, Meta, and Nvidia have "offset the typical pattern of negative revisions to consensus EPS estimates."

"We underappreciated the degree to which those earnings would lift those few stocks and the degree to which those few stocks would drive the rest of the market, and that's basically what we're adjusting for," Goldman Sachs equity strategist Ben Snider told Yahoo Finance.

Goldman Sachs laid out an alternative scenario to their base case call for 5,600 on the S&P 500, where the benchmark skyrockets to 6,300 by the end of the year. This, Goldman's team wrote, would be driven by "further mega-cap exceptionalism."

Snider told Yahoo Finance this possibility would likely come from "continued revenue beats from those companies relative to what analysts expect." Snider added that such a scenario leaves investors "vulnerable" to a few stocks beating expectations. But it still comes with an upside.

"The beauty of the S&P 500 index ownership in general, which is when a few companies perform really well, they can drag up the whole index," Snider said. "And we're seeing that right now. So I think most investors who own the S&P 500 are very happy with what's happened, even if it means their underlying portfolios are more concentrated," Snider said.

Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2024 in New York City. Wall Street stocks opened little changed May 17 after pulling back from a record run where the Dow exceeded 40,000 points for the first time. Around 10 minutes into trading the Dow Jones Industrial Average was steady at 39,872.66. (Photo by ANGELA WEISS / AFP) (Photo by ANGELA WEISS/AFP via Getty Images)
Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2024, in New York City. (ANGELA WEISS/AFP via Getty Images) (ANGELA WEISS via Getty Images)

Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

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