"My jaw about hit the floor halfway through the conversation..."
That was what my colleague Sam Latter said to me last week. A friend of his had reached out to him, seeking advice about moving some money around.
"I haven't done anything," his friend explained. "But I feel uncomfortable with my dependence on Nvidia. It's more than double my Apple, which used to dominate my portfolio."
"What percentage of your portfolio is it?" Sam asked.
"Thirty-three percent in one. Forty-one percent in another."
Sam was shocked...
"Well, no single stock, even one that's crushing it, should ever make up 30% of your portfolio," he said. "We both know that."
Simply put, 30% to 40% is way too big a stake for any investor to have in a single company. That's true even for giants like Nvidia.
Sam's friend has every right to feel uneasy. But even if you're not invested in a single mega-winner stock like Nvidia, this problem likely applies to you too...
After such a big run to the upside, investor expectations for tech giants like Nvidia are sky-high. But those expectations are starting to catch up with reality...
We saw this dynamic play out just last Wednesday. Nvidia reported its third-quarter earnings – and the results were an absolute blowout.
The chipmaker's revenue soared an incredible 94% from the same period last year. And earnings per share shot up a staggering 103%.
These kinds of results would send a normal stock soaring... But Nvidia is no normal stock. Despite crushing the third quarter, shares fell 2% the night after results were announced.
The fact is, NVDA is so highly valued that it can't easily beat investor expectations. It's a victim of its own reputation.
But this isn't just an Nvidia problem. It affects the entire S&P 500 Index, too...
See, the S&P 500 is weighted by market capitalization. That means that the more a company outperforms, the bigger a piece of the pie it takes up in the index...
And because the market has been dominated by the "Magnificent Seven" tech stocks for years, the S&P 500 has grown extremely top-heavy. Take a look...
Investing in the S&P 500 means you're placing nearly 31% of that money into just seven tech companies – whether you know it or not. And just like Nvidia, these tech giants are darn expensive today...
We can see it by comparing the price-to-earnings (P/E) ratio of the tech sector with that of the other sectors in the S&P 500. The higher this ratio, the more expensive the stock... and the more downside potential should it fail to perform.
Look how tech stacks up against the rest of the market based on the last 12 months ("LTM")...
Today, tech has a P/E ratio of 39.3, making it the most expensive sector after real estate. (For reference, Nvidia has a P/E ratio of 51... making it even pricier.)
Like Sam's friend, investors in the S&P 500 are keeping their eggs in one basket... And at these valuations, that basket has a lot more downside potential than upside today.
So even if you're investing passively, you're probably taking on more risk than you think.
To make your portfolio less top-heavy, consider buying an "equal weight" fund. These funds put an equivalent share of your cash into every company in the index, regardless of size.
The Invesco S&P 500 Equal Weight Fund (RSP) tracks the broad index. Currently, its P/E ratio sits at a lean 16. Or if you want to keep a focus on tech, the Invesco S&P 500 Equal Weight Technology Fund (RSPT) is a good way to go. Right now, it has a P/E ratio of just 23.
There are safer – and likely more profitable – ways to deploy your cash as the bull market continues. And if you want to take some risk off the table, consider buying an equal-weight fund today.
Good investing,
Sean Michael Cummings
Further Reading
"It's not plain old excitement you have to worry about," Brett Eversole writes. "It's euphoria." This month's postelection rally is in danger of getting ahead of itself. So we're keeping a close eye on signs that euphoria is near... Read more here.
"You don't find much success in life by just doing what everyone else is doing," Dr. David Eifrig writes. Investors are piling into highly valued tech stocks like Nvidia. But this "irrational exuberance" can lead to disastrous losses when things turn sour – and there are better places to put your money today... Learn more here.
HIGHS AND LOWS
NEW HIGHS OF NOTE LAST WEEK
W.R. Berkley (WRB)... insurance
Allstate (ALL)... insurance
Progressive (PGR)... insurance
Nasdaq (NDAQ)... stock exchanges
Twilio (TWLO)... cloud services
Atlassian (TEAM)... collaboration software
Take-Two Interactive Software (TTWO)... video games
Live Nation Entertainment (LYV)... live events
Royal Caribbean Cruises (RCL)... cruises
Brinker International (EAT)... restaurants
Walmart (WMT)... discount retail king
AT&T (T)... telecom
Altria (MO)... cigarettes and alternatives
Deere (DE)... farm equipment
Cummins (CMI)... diesel engines
Owens Corning (OC)... roofing and insulation
Lennox (LII)... HVAC systems
Eaton (ETN)... power management
Waste Connections (WCN)... trash and recycling
Ameren (AEE)... utilities
Enterprise Products Partners (EPD)... oil and gas
NEW LOWS OF NOTE LAST WEEK
Baidu (BIDU)... "China's Google"
Kohl's (KSS)... apparel
Mondelez International (MDLZ)... candy and snacks
LyondellBasell Industries (LYB)... chemicals
Scorpio Tankers (STNG)... oil-tanker shipping
