
Cross-currents: Robust earnings vs concentration risks. Despite geopolitical tensions in the Middle East and surging bond yields, the S&P 500 has rallied sharply this year with AI plays contributing the bulk of the returns. A dissection of S&P 500 performance unveiled both good and bad news.
On the positive front, this rally is truly backed by fundamentals. YTD, the index is up 10%, entirely supported by forward earnings growth which surged 26%, aided in part by the 2.7% increase in operating margins. On the flipside, valuation actually fell 13% this year to 22.4x forward P/E. Given the robust outlook for AI-related industries, we expect the positive earnings momentum to persist in the coming quarters.
Now, the bad news. While the rally is strong, the market has also become extremely lopsided and concentrated. Big Tech and AI infrastructure stocks dominate the upside and today, the top 10 contributors generate c.78% of index gains while the median company is sitting c.13% below its 52-week high. Take Google for instance. The company accounts for c.6.5% of S&P 500 market cap and single-handedly contributed c.16.5% of market returns. The same goes for Nvidia, which accounts for 7.4% of market weight and 14.9% of the returns.
Historically, high market concentration risk does not necessarily mean that the rally will come to an end. But from a portfolio concentration standpoint, such narrow up-moves do deserve attention as they tend to precede higher volatility and below average forward returns even during times when the macro backdrop is supportive.

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