The S&P 500 Growth Index has been outperforming the overall S&P 500 and the S&P Value Index over the past two years, with a 57.3% surge compared to 41.6% and 23.8% gains respectively. Despite this impressive performance, only 40% of the stocks in the growth index have generated positive returns in the last month, raising questions about the sustainability of this trend. Growth stocks are defined by high scores in sales growth, earnings change to price ratio, and momentum, while value stocks are identified by book value, price-to-earnings ratio, and sales-to-price ratios.
Investors have been flocking to growth stocks like Microsoft, Nvidia, and Apple, driving up their stock prices due to their consistently strong revenue and profit growth. These companies have seen their earnings accelerate, leading to higher stock prices and valuations. The price-to-earnings ratio of the S&P 500 Growth Index has expanded to 34.9x, while the value stocks have seen a decline in their P/E ratio. Investors are willing to pay higher valuations for growth stocks, betting on the continued success of a few companies rather than blindly investing in all growth stocks.
The performance of the S&P 500 Growth Index has been largely driven by a handful of mega-cap stocks. The largest 10% of companies in the index, with market capitalizations of over $1 trillion, have been responsible for all the returns of the index. Only one other market cap decile has seen positive returns, while the rest have had negative returns over the last month. The top 10 stocks in the S&P 500 Growth Index account for over 60% of the return, despite there being 228 stocks in the index.
Investors have benefited from the dominance of mega-cap growth stocks so far, as companies like Microsoft, Nvidia, and Apple continue to deliver on revenue and earnings expectations. However, there is a risk of complacency in the face of this trend. If the artificial intelligence boom slows down or the economy falters, the premium that investors are willing to pay for these large growth stocks could decrease. This could lead to higher volatility in the market, with the few leading companies today potentially leading the market lower in the future.
Despite the impressive run of growth stocks, investors should remain cautious and prepared for potential market shifts. The current market trend may change if the dominance of mega-cap growth stocks weakens, leading to increased uncertainty and volatility. It is important to stay vigilant and aware of market dynamics, as the few companies driving the market higher now could easily reverse course and drive it lower in the future. In conclusion, while growth stocks have been the star performers in recent years, diversification and risk management strategies are key for investors to navigate potential changes in the market.
