Last Thursday, September 3, equity markets plunged dramatically, in a sharp reversal of the mostly upward course they’ve been on for most of the summer. The drop was led by steep price declines in the value of the major tech stocks, especially Apple, Microsoft, Nvidia, and Zoom. Electric car manufacturer Tesla also contributed to the downward movement. And yesterday, on the first trading day after Labor Day, techs declined again.
For investors holding index funds—especially those mirroring the popular S&P 500 index—it is important to recognize that the big tech stocks, because of their very high market valuations, make up a significant percentage of the value of the index. Therefore, any major price swings in tech, positive or negative, will typically exert an outsized influence on the value of the index and its related index funds.
This type of thing has happened before, certainly. In the early 1960s, for example, the so-called “Nifty Fifty” stocks—including companies that are still with us such as Coca-Cola, General Electric, and IBM, as well as companies that are currently struggling or nonexistent, such as Polaroid and Xerox—were driving a bull market. These stocks also made up more than a quarter of the value of the S&P 500 index. However, that market came to an end, as all bull markets eventually do.
Today, the big tech stocks make up nearly a fifth of the S&P 500 market valuation. In recent years, this sector has benefitted from rapid growth, and investor sentiment has followed suit, pushing share prices of these companies to unprecedented highs. As the stocks gain in value, those valuations tend to overweight the overall index in their favor.
In the normal course of events, however, what goes up must come down, at least somewhat. At some point in time—which no one can predict with absolute accuracy—investors begin to believe that stock prices are getting too far ahead of actual values, and they will start to take profits. When this happens, equity prices will begin to fall back toward a level that investors believe more fairly represents their real worth. This can happen in any sector: value stocks, growth stocks, financial stocks, energy stocks, and others. Most analysts assert that such pricing adjustments are a normal part of the functioning of efficient markets, as the buying and selling decisions of millions of individual entities are factored into the price of market-traded assets.
What is the takeaway for the individual investor? I believe that this latest price development in tech stocks points to the importance of maintaining broad diversification, keeping your asset allocation in line with your long-term goals and risk tolerance, and remaining disciplined and patient. I would advise against either “dumping” tech stocks in an effort to avoid further losses, or “going all in” on tech to try and capture a supposed price bounce from the recent drops. Such attempts, based on reactions to recent market events, rarely lead to long-term enhancement of your portfolio.
I would appreciate the opportunity to meet with you and discuss recent market events or any other financial topic that is on your mind. If I can help in any way, please contact my office for an appointment. And to read my related article, “Splitting the Difference: Apple, Tesla, and Your Portfolio,” please click here.
Stay Diversified, Stay YOUR Course!