The market has changed. A couple weeks ago, it was all about tariffs and China trade wars. Now, there's new uncertainty around earnings and how it may impact the market leader, technology.
A social media crisis with Facebook that may also affect other social media stocks and Alphabet potentially as well. Driverless-car issues affecting Nvidia and Tesla (which got a downgrade from Moody's). Apple getting hit after Goldman cut iPhone sales estimates.
Here's the problem: Technology has gotten way too big for its britches. It's so big that as tech goes, so goes the S&P 500. And that is very risky.
Here's one way to look at it: The three biggest stocks in the S&P 500 by market capitalization — Apple, Amazon and Alphabet — have a market cap of $2.3 trillion. The S&P 500 has a total market cap of about $23 trillion.
Think about this: Three stocks now make up 10 percent of the entire S&P 500.
Throw in Microsoft and Facebook — which together have a market cap of $1.1 trillion — and the Big Five tech stocks make up 15 percent of the S&P 500.
Wait — it gets worse. Here's a breakdown of the market cap of the S&P sectors:
S&P 500: Market Cap
- Technology 25%
- Financials 15%
- Health Care, Industrials, Discretionary, Staples: 45%
- Energy, Materials, Utilities, REITs, Telecom: 15%
The first thing to notice: Technology is 25 percent of the S&P, so it's really true — as goes tech, so goes the S&P 500. Combine it with financials (mostly banks), and those two groups make up 40 percent of the S&P 500.
Now look at the bottom group: Energy, materials, utilities, REITs, telecom are only 15 percent of the S&P 500 — just five sectors.
It's fine if you want to rotate out of tech and buy utilities, but if you are owning large swaths of the market in the form of mutual funds or ETFs — and I mean owning the S&P 500 — they are not going to matter much.
What does matter is what I call the "swing groups" — health care, industrials, consumer discretionary and consumer staples — that make up 45 percent of the S&P 500. These are the groups that really matter, because if technology and financials falter, as they are doing now, these four are the only ones with the "heft" that will make a difference.
They are the ones investors will rotate into, providing the market is healthy and earnings are rising.
Here's the problem: The big earnings growth is in technology (expected to grow 23 percent in the first quarter) and financials (24 percent). Health care and industrials have earnings growth in the mid-teens, consumer discretionary and consumer staples only have about 9 percent earnings growth.
See the problem?
The biggest market cap sectors have the biggest earnings growth. That's why the market is so vulnerable to a sell-off when the earnings quality of its largest group is called into question.