Market Update: Technology and the S&P 500's Impressive Run. Is it Sustainable?

Technology and the S&P 500’s Impressive Run. Is it Sustainable?

Technology has led this market higher and higher last year and continues to push even higher into 2024. Technology along with the S&P 500, are sitting at just about the all-time highs reached one month ago in December. Can the Technology and the S&P 500 continue to make new highs? Can the S&P 500 maintain gains without Technology?

Topics

S&P 500 Weighting

Technology Valuation

Technology Earnings Growth

S&P 500 Weighting 

The technology sector is a 29.1% weighting in the S&P 500. However, this does not include Alphabet (Communications), Meta (Communications), Amazon (consumer Discretionary), and Tesla (Consumer Discretionary). If those were added into the sector, the weighting would be 40%.

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Due to this very large weighting technology has the biggest impact on the market. If this sector (plus the missing 4) were to decrease by 20% and every other sector remained the same the S&P 500 would drop 8%. If Energy for example, with a 4% weighting went up by 100% and everything remained the same the S&P 500 would move up by 4%. If both happened and all other sectors remained the same the index would drop by 4%.

Being invested in the index is being invested in technology. Because of the high weighting, it is difficult for the other sectors to have a meaningful impact on index returns. For the past few years, there has been a very high correlation between these two returns. 

Technology Valuation

Technology valuations are getting stretched vs. their historical numbers. The current forward P/E (2024 predicted earnings) of the Technology sector is 26.3x. Add in the missing four Big Tech companies and that would jump to 28.2x.

The 10-year historical average for this sector is 20x their forward earnings. We are close to the highs of 2020 and 2021 which was around 28-29x forward earnings. Technology is at 26.3x without the missing four Big Technology companies (Alphabet, Meta, Amazon, and Tesla). Those were removed in 2018.

What the Forward PE Ratio tells us is that this sector valuation is justified as long as it meets or exceeds the predicted earnings for the year. The drop in 2022 was a result of a drop in predicted earnings.

Technology Earnings Growth 

The technology sector gets a higher valuation due to the earnings growth and percentage of earnings compared to the other sectors. This is the main reason why this sector gets such a big weighting and valuation.

Most of the money companies make in the S&P 500 is produced by technology companies and this number grows pretty steadily. These are the best-growing streams of cash investors can find. The earnings coming from Technology have doubled since 2019 and are expected to continue to grow another 20% this year led by the semiconductors. 

In 2022, earnings growth for technology was flat year-over-year and this brought the valuations down and the Forward PE down to about 20x. This would represent an approximate 20-30% downside if it were to return to those levels. Which is right around its 10-year average.

The only other area with this type of earnings growth is Healthcare. The benefit of healthcare is that it’s trading at a lower Forward PE of about 18x, vs. Technology’s 26x. Love it or hate it Healthcare is a high-priority item to humans and these companies make a lot of money.

Conclusion: Can Technology and the S&P 500 continue to go up?

To start, the S&P 500 moves with Technology. There is very little the other companies or sectors can do to alter that course. Unless there is a rotation and people sell Technology and move those funds into other sectors as opposed to moving to cash or bonds. This is a difficult call because the valuations are high, and history would suggest this is a sell situation, but it is difficult to find earnings growth in other sectors. That being said earnings growth, is very coveted and is keeping money in the space. But if that falters expect the valuations to correct, and in turn, the S&P 500 most likely will also.

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Sincerely,

Justin, Konrad, and Merriel

More articles and information are available at www.knowprotectgrow.com 

Content Sources: Bloomberg, Trading Economics, Yahoo Finance, BCA Research

Disclaimer: This newsletter is solely the work of Konrad Kopacz and Justin Lim for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.

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