After briefly being anointed king of the stock market, Nvidia is getting hit hard. While this could be a red flag for investors worried that this year’s rally has been too reliant on a few big tech names, there are plenty of ways to avoid bubble prices while remaining broadly invested.
Just last Tuesday, Nvidia briefly overtook Microsoft to become the world’s most valuable company. Since then, investors have turned to the artificial intelligence chipmaker, sending its shares down nearly 13% over the past three trading days.
Nvidia’s problems aren’t just a potential problem for AI evangelists. Nvidia and other members of the so-called Magnificent Seven tech stock club have driven much of the market’s overall gains over the past few years. Technology stocks now have about a third of the weighting
S&P 500,
up from less than 25% in 2019.
Nvidia’s valuation — trading at about 70 times earnings — suggests the stock could fall further. While the price/earnings ratios of other tech names dominating the market aren’t as extreme, these stocks are also richly valued. Actions that make up
Technology Select Sector SPDR
exchange-traded funds trade at 29 times earnings, according to Morningstar, well above the broader market’s 21 times.
For investors, the combination of large index weights and high valuations represents a risk. If traders were to suddenly give up on big tech stocks, weakness in the sector could be enough to trigger a bear market by itself, notes independent Wall Street researcher Jim Paulsen.
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“The infamous Mag7 (and possibly a handful of other notables) have rallied spectacularly, and if they collapse — due to their overweights — the S&P 500 could suffer a 20%+ decline,” he writes.
Fortunately, Paulsen also notes that the high-end nature of the market includes silver. While Nvidia and other high-tech stocks surged ahead, many corners of the market — including materials, industrials and consumer stocks — lagged behind. They have averaged annual returns in the low to mid-single digits over the past few years.
“Normally, when the S&P 500 is extended and overbought, most stocks in the index enjoy significant bull participation and the S&P shows extended bear vulnerability,” Paulsen writes. “However, in the current bull market, concentration is so intense that most stocks have not participated much, making the Bear’s job much more difficult.”
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Today’s P/E numbers reflect that momentum, giving valuation-wary investors like Nvidia plenty of opportunities to bet on the stock market without getting caught in the bubble. Check out the Invesco S&P 500 Equal Weight ETF, which holds roughly equal amounts of all the stocks in the index, rather than matching stock weights to their market values ​​like the S&P 500 does.
The fund’s allocation to technology stocks is a substantial but not overwhelming 16%. Its portfolio trades at 18 times earnings, a hair below the long-term market average of 19.
Another approach is small-cap stocks, which have lagged large-cap stocks for eight of the past 10 years. The
iShares Russell 2000 ETF
is even cheaper: The stocks it owns trade for just 15 times earnings on average.
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Sure, betting on underperforming stocks means investors can miss out on some of the momentum of big AI-powered tech. But when sentiment turns, the market is much less likely to punish stocks whose prices seem easily justified by their quarterly earnings.
It could save investors a lot of pain.
Email Ian Salisbury at ian.salisbury@barrons.com