Does it need diversification? The new technology bubble. The economy is humming or is it?

Chart of the week

The chart shows the broad market index of the U.S., the S&P 500 (orange) and an index consisting only of the FANG+ stocks (blue) since 2014.
The FANG+ stocks include: The original FANG stocks; Facebook (meta), Apple, Netflix and Google. With the "+" the following additional stocks are included: Amazon, Microsoft, Tesla, NVIDIA, Snowflake and AMD.

Why it matters
Every investment advisor tells you how important it is to have a diversified portfolio with lots of stocks. This chart seems to disprove that. With just ten stocks, you have a return that is many times higher than the broad market index.

But hand on heart, would you really have identified those ten stocks as the best in 2014? In America, there are about 4,000 listed stocks, The 500 largest of which are grouped together in the S&P 500. Today, everyone knows these stocks, but in 2014, Tesla, Netflix or NVIDIA were still unknown to many.

Of the stocks listed in 2014, about 150 no longer exist today. The companies have gone bankrupt.

The probability that you would have chosen the ten right stocks in 2014 is much smaller than that you would have lost all your money.
The new technology bubble

The chart shows how much money flowed into technology stocks on the U.S. stock market last week. It was the highest amount in 20 years. Some of the companies have assumed valuations that cannot be reached even with the most optimistic assumptions. As soon as AI (Artifical Intelligence) is associated with a stock, investors grab it blindly.

Certainly AI will have a big impact and many companies will make money with it, but not all by far and not as much as currently assumed.
Here is an example to illustrate this. NVIDIA is currently trading at a P/E (price-to-earnings ratio of 2024) of 63. This means that if an investor were to buy the entire company today, he would only make a profit after 63 years. At the same time, the profit in all 63 years would have to be at least as high as that expected for 2024.

For comparison, Nestle is trading at a P/E of 23.5. I would feel safer with a stock like Nestle than with NVIDIA.

The chart shows a measure of market breadth. That is, how many stocks move the index in one direction. The market is currently driven upwards almost exclusively by the FANG+ stocks. Market breadth is the lowest it has been since 1990. Low market breadth is most often a harbinger of a stock market correction.

The economy is humming, or is it?

Since the beginning of the year, many investors have been expecting a recession, but both economic indicators and company results have surprised with strong figures. The chart shows the Bloomberg Economic surprise Index. So how many results surprise positively. We are now entering a phase where it is becoming increasingly difficult to surprise the market positively.
We see the reason for the many positive surprises in the company results in the margins of the companies. In and after the COVID period, many companies had to deal with higher costs, raw materials and delivery problems. They had to raise prices. Now, however, these costs have come down again, but prices have not been lowered again. However, this is a short-term effect. Because many companies now have to deal with rising labor costs.

The graph shows real labor costs in America (light blue, inverse scale) and companies' margins (dark blue). There is a very high correlation between the two variables. Rising wage expenses lead to falling margins. This is exactly what we are experiencing now.

But the companies could counteract the higher costs with increasing sales.

The chart shows a survey of US purchasing managers. Most companies are facing falling order intake (blue). Factories are still running at full speed, but orders are being processed that still arrived in 2022. The order book (orange) is getting smaller. It is therefore only a matter of time before production is also reduced and, as a result, the companies' earnings also fall.

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