By Ben Levisohn
Investors like to think of themselves as brave individuals, forging their own path through the markets. Such individuality is getting harder to defend.
In a perfect world, we'd be rewarded for our stock-picking prowess, but in this one all you need is the Magnificent Seven. Since the start of 2023, those stocks -- Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla -- have returned more than 50%, beating the "S&P 493" by 18 percentage points, according to Warren Pies, co-founder of 3Fourteen Research.
For the equal-weighted S&P 500, where each stock counts the same toward the index's performance, it's been even worse -- it's up just 27% during the first 425 days of this bull market, about half the S&P 500's gain and a fraction of its typical bull market return. "Narrow market leadership is another way of referencing the awesome outperformance of the 'Mag 7' compared to the rest of the market," Pies writes.
For all you index-fund owners reading this, that concentration of performance isn't an issue, at least not yet. It is for stockpickers, though, and they appear to have decided that the solution for a concentrated market is concentration. BofA Securities strategist Savita Subramanian notes that the average large-cap fund has a third of its portfolio in just five stocks, up from 26% in December 2022, while a quarter of all large-cap funds have more than 40% of their portfolio in five stocks, up from 5%. "Funds' concentration risks have grown alongside the benchmarks'," she writes.
Many of the funds are concentrated in the same stocks. That hasn't been a problem for large-cap core funds, which are benchmarked to the Russell 1000 index. Their most overweighted stocks -- Meta, Eli Lilly, and Microsoft among them -- were a massive source of outperformance in the second quarter, according to Jefferies strategist Steven DeSanctis. For large-cap growth funds, by contrast, the 10 most crowded stocks, which include Nvidia, Meta, and Amazon, underperformed. They gained an average of 8%, below the Russell 1000 Growth index's 8.6% rise.
Finding other options, though, hasn't been easy -- and in some cases it's downright painful. Looking for "value" in beaten-up stocks has too often been a way to lose money. Take Walgreens Boots Alliance. Six years ago, its shares were seen as a solid bet, at least by the folks at S&P Dow Jones Indices, who added it to the Dow Jones Industrial Average, replacing General Electric, which had fallen on hard times. Walgreens has since run into its own difficulties and was booted from the blue-chip benchmark earlier this year.
Heading into its earnings report this past Thursday, it was hard to imagine things getting much worse for the company, whose stock had fallen more than 80% from its 2015 high. With a new CEO, Tim Wentworth, in place since October, the focus had turned to strategy, not actual earnings or sales -- or so it was thought. And with shares trading at just over five times earnings before the announcement, any bad news seemed to be priced in. But then Walgreens reported a profit of 63 cents a share, below forecasts for 68 cents.
Worse than the miss, however, were comments from Wentworth.
"We are at a point where the current pharmacy model is not sustainable, and the challenges in our operating environment require we approach the market differently," he told investors. Part of that approach will be closing as many as a quarter of its stores. The stock dropped 22% on Thursday and now trades at 4.2 times earnings.
Airlines have typically been lousy investments, but Southwest Airlines was thought to be the exception. No longer. The stock has dropped 21% in the past 12 months, worse than the 6.2% decline in the U.S. Global Jets exchange-traded fund, continuing a slide following a disastrous holiday season in 2022. Improvement is hard to find. This past Wednesday, Southwest said that its revenue per available seat mile, an industry metric, would drop to 4%-4.5%, down from its previous guidance of 1.5%-3.5%. Maybe activist investor Elliott Investment Management, which recently took a stake in the company, has an idea how to turn Southwest around, because we're at a loss.
Even once-solid growth companies have stumbled. Nike stock, a Barron's pick , tumbled 20% on Friday after the company reported earnings following Thursday's close. The hope had been that its new sneakers, combined with the start of the summer Olympics, would mean the end of a sales slump that had helped knock its stock down 32% over the past three years.
Nike's new products appear to be selling. But its "lifestyle brands," such as Air Force 1, AJ 1, and Dunk, continue to slump. "Nike's 4Q report indicated its fundamental trends are much worse than we realized, " writes UBS analyst Jay Sole. "Our key conclusion is there will be no quick rebound for Nike's earnings." Nike isn't alone in this group of once-steady growth stocks. Others that have fallen on hard times include Starbucks, UnitedHealth Group, and Ulta Beauty.
But if old favorites can't be bought on weakness, what can? Software stocks, which had fallen out of favor as artificial intelligence dominated the market and investors' imaginations, look like a good bet. The iShares Expanded Tech-Software Sector ETF has risen just 6.6% in 2024, more than 10 points less than the 18% gain in the Technology Select Sector SPDR ETF and just a seventh of the 48% return in the VanEck Semiconductor ETF. The concern is that all the spending on AI will shift dollars away from software. Earnings season confirmed some of those fears, with more than half of the software stocks guiding lower, according to Citigroup data.
But software has started looking healthier. The Software ETF gained 11% in June, better than the Technology Select Sector SPDR's 7.7% rise or the 4.3% advance in the iShares Semiconductor ETF. That outperformance should continue, argues Seaport Global strategist Victor Cossel. For evidence, he points to the dramatic responses to Adobe's earnings on June 13 -- the stock, which had been seen as an AI loser, jumped 14% on June 14 -- and Micron Technology's on June 27, when the stock dropped 7.1% despite what seemed like a perfectly adequate quarter.
That's a sign that market sentiment toward software may have started to shift, especially as investors begin to identify companies that can benefit from AI, including Adobe, Salesforce, and ServiceNow. "We think the inflection for software stocks is more than just a short-term sentiment swing," Cossel writes.
Let's hope so. It can't be the same stocks all the time, can it?
Write to Ben Levisohn at Ben.Levisohn@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
June 28, 2024 15:54 ET (19:54 GMT)
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