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The stock story for the first half of 2024 is unambiguously bright. The US benchmark S&P 500 is up about 15%. Its tech-heavy cousin, the Nasdaq Composite, has made further gains. Most European countries are performing well, including the UK (but not you, France), and Chinese stocks have finally stopped losing ground.
Central banks are taking a slightly cautious victory lap in their mission to beat inflation without crashing the global economy, judging by the Bank for International Settlements’ annual economic report, which praises policymakers for “doing their jobs” and “keeping their promises” in supporting a soft economic landing. Kudos to all.
Yet the mood in markets remains fragile, with investors struggling to shake the impression that things are simply sprinkled with glitter. The rally in US stocks has slowed, with barely any movement in the last two weeks. Crucially, Nvidia – not the best-performing US stock of the year, but certainly the most important, in terms of the overall market direction – has taken a hit. Since peaking on June 20, it has fallen 13%.
Torsten Slok, chief economist at private equity group Apollo, said the index looks “more vulnerable.” The top 10 companies in the S&P 500 account for 35% of the index’s total value, but only 23% of its earnings. “This divergence is at an all-time high, suggesting that the market is historically optimistic about the future earnings of the top 10 companies in the index,” he wrote. “In other words, the problem with the S&P 500 today is not just high concentration, but also record optimism about the future earnings of a small group of companies.”
Sometimes it works. After all, it was thanks to a healthy number of Tesla deliveries that the overall market hit its new record this week, the 32nd of the year. But attention is intensifying on the highly uneven nature of the market.
Charles Schwab points out that only 17% of stocks in the S&P 500 have outperformed the index itself over the past year. For the Nasdaq, that figure is just 11%. “The spectacular outperformance of a small handful of stocks at the upper end of the market-cap spectrum has greatly flattered index-level performance among the cap-weighted indices,” wrote analysts Liz Ann Sonders and Kevin Gordon at the retail brokerage. “There has been a considerable amount of rotation and rotational corrections going on beneath the surface.”
It’s the glitter that’s in action. Everything related to artificial intelligence has exploded, including chip designer Nvidia with its gains of 155% so far in 2024, but also the even flashier Super Micro Computer, which has gained more than 200%. A group of energy and industrial stocks that help AI work are also surging, including Vistra and Constellation Energy.
Another alarming possibility presents itself in a new paper written by, among others, Jean-Philippe Bouchaud of the hedge fund Capital Fund Management. The paper, somewhat provocatively titled “Ponzi Funds,” challenges anyone who clings to the strange idea that fundamentals—earnings and the like—are what really matter when it comes to stock behavior.
In short, funds rise because investors can’t resist buying stocks that rise, and when they do, the underlying components rise too, which pushes the funds higher and attracts new buyers. Momentum feeds momentum in “self-inflating feedback loops” and coalesces around shiny narratives. At some point, “the constraint on fund investors’ rationality … leads to Ponzi-like capital reallocations among fund investors that unwind when the price impact on the underlying securities reverses,” the article states.
The study focuses on exchange-traded funds (ETFs) because the quality of data on buying and selling in these instruments is good, but the principle applies to stocks more generally. The dynamics of U.S. stocks and the dominance of a single theme make the current market environment terribly similar. “The U.S. market went up because people bought the U.S. market,” Bouchaud said.
This line of research is certainly not new. “We are following in a long tradition of many giants before us,” he added. None of this makes it easy to see what breaks the spell and causes markets to fall back to earth, or when.
But if U.S. stocks don’t resume their meteoric rise soon, it’s easy to imagine that lingering doubts about intense market concentration and reminders of the unsustainable nature of fads and trends will take some of the shine off stocks in the second half of this year.
katie.martin@ft.com
