S&P 500 Needs The Mega-Caps To Step Up

S&P 500 Underpinned By High Valuations

At the start of the year, we noted that the S&P 500 was sensitive to economic data and earnings, whether on the fundamental, macro, or technical side.  

That the S&P 500 was priced to perfection. Valuations were high, and any change in economic data outside of stock market expectations would likely result in a sharp correction.

The correction became reality on the Liberation Day announcements.

Given the unprecedented rally in stocks, our assessment of the S&P 500 today mirrors that of the start of the year.

Replicating the stellar returns of the past decade won’t be easy for the U.S. stock market. It would require historically high valuations or unprecedented earnings growth. 

If economic growth and earnings continue to hold up, U.S. shares can likely sustain their elevated valuations in the short term. That said, the positive effects of earnings and growth are likely to diminish in the longer term.

Ultimately, high valuations may drag down long-term returns for investors.

Mega-Cap Stocks

Mega-cap stocks account for one-third of the S&P 500’s value and delivered more than half of its growth in the recent rally.

AI expectations, in part, drive the valuations of mega-cap companies.

Will AI be more significant than the Internet? Yes.

However, investors want to see returns on AI capital expenditure. They want to see business models and lifestyle changes driven by AI within the next twelve to fifteen months that deliver returns on investment. 

It was the absence of returns on invested capital that led to the crash of internet stocks.

AI-linked technology shares currently have high valuations. Much of the returns from AI are already priced in.

Additionally, during periods of technological transformation, the tech sector, in general, has historically not outperformed.

If AI is going to transform the economy, which is the more likely scenario, its benefits will extend far beyond the technology sector. Companies outside the tech sector are likely to benefit the most.

If that is the outcome, then the momentum of mega-cap stocks may stall.

S&P 500 Key Levels

The S&P 500 opens in positive gamma today.

The gamma flip zone has moved up and sits at 6200; the call resistance level is 6400, and the put support level is 6050.

The weight of probability is momentum to the upside.

That said, earnings, particularly net income and operating margins, coupled with the Fed interest rate decision and non farm payroll, will likely determine the market’s direction.