Indexing Drives Market Behavior | The Investors Edge

By John Stewart, chief investment officer at Farmers Trust Co.

Week in Review: Uncertainty Rising

The stock market has slowed it upward momentum after the blockbuster earnings report from AI chipmaker and market darling NVIDIA last week.

Despite the 20% bump in that stock since reporting earnings, the broader stock market is down about 1% over the same time frame.  And if you strip NVIDIA out of the index, the rest of the S&P is down about 2% in the past week and a half.

The future is always uncertain, but investors are all of a sudden becoming more concerned that maybe economic growth isn’t as strong as they thought, perhaps the inflation genie hasn’t been put back in the bottle just yet, and perhaps interest rates will stay higher for longer than previously thought.

Then you could always throw in geopolitical conflict, some hot wars, others just brewing discord, as well as a very consequential election coming up later this year to create even more uncertainty.

With the stock market trading at historically elevated valuations, there’s not much room for error.  Perhaps investors are starting to wake up to the risk side of the equation after focusing on maxing out returns for the past 18 months.

Featured Insight: Indexing Drives Market Behavior

Over the past couple of decades there has been a significant push toward buying a market index like the S&P 500 rather than picking individual stocks in an attempt to outperform the market.

This makes sense for a lot of investors who simply want an easy option for buy and hold investing over a long period of time; it has also been a trend that has created a self-fulfilling performance dynamic.

The more investors buy the index, the more the largest stocks in the index go up, which in turn causes other investors to chase those stocks, which causes the index to move higher still.

The problem ultimately becomes a highly concentrated market, however, where just a handful of stocks make up a significant portion of the overall index.  The so-called Magnificent 7, or the seven largest stocks in the S&P 500 make up roughly 30% of the overall index despite the index having another 493 stocks in it.

For example, many money managers HAVE to buy NVIDIA shares because the company makes up a fairly significant 6% of the index, that’s bigger than some entire sectors like Utilities and Energy.

It’s important to know that if and when momentum shifts, this dynamic works in the other direction, too.

Looking Ahead: Seasonal Lull

With earnings season for all intents and purposes now over, investors will be watching key economic data reported during the month of June.

It’s always important to keep an eye on economic data of course, but with school letting out, and the start of summer vacation season, a lot of investors will be heading to the beach.

In all likelihood, the next few weeks should be a period of calm with minimal volatility.

Nevertheless, it’s during those times where nothing is expected to happen that something unexpected has the power to take center stage.

For investors who’ve taken advantage of the market rally over the past 18 months, it could be an opportunity to use the market calm to harvest some profits.  And for investors who are looking to add exposure, any unexpected volatility could be a good chance to buy some quality companies on sale.

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