US megacap stocks tested by soaring bond yields

These stocks accounted for more than 80% of the S&P 500's total return for 2023

With a collective weighting of 27 per cent in the S&P 500, weakness in the megacaps could further deflate the broader index. Reuters

Surging bond yields are rattling US stocks, and some investors worry the richly valued shares of giant technology and growth companies may be another weak spot.

Seven megacap stocks – Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta Platforms – have led broader markets higher this year.

As of Tuesday, these stocks accounted for more than 80 per cent of the S&P 500's total return for 2023.

Investors see many of the stocks as major beneficiaries of advances in artificial intelligence.

This year, megacaps' strong balance sheets and business models also attracted those looking for a safe haven when regional banking turmoil shook the financial system.

Their rising stock prices ballooned valuations, however, and some investors say the megacaps could be vulnerable if climbing bond yields keep pressuring stocks.

The so-called Magnificent Seven stocks trade at an average price-to-earnings ratio of 31.8 based on earnings estimates for the next 12 months, according to LSEG Datastream. That far surpasses the S&P 500's ratio of 18.1.

With a collective weighting of 27 per cent in the S&P 500, weakness in the megacaps could further deflate the broader index, now down 6.6 per cent from its July highs, investors said. Year-to-date, the S&P 500 is up more than 11 per cent.

“When the big tech stocks start going down … the indexes go down,” said Matt Maley, chief market strategist at Miller Tabak. “Then people get nervous and sell their mutual funds or their ETFs, and … the whole thing snowballs.”

The recent stock sell-off has dented some megacaps, with Apple – the largest company by market value – dropping about 13 per cent since late July.

High-flyer Nvidia fell nearly 12 per cent in September. Apple remains up 32 per cent for the year, with Nvidia up nearly 200 per cent.

Higher yields on Treasuries – which are sensitive to rate expectations and regarded as risk-free – offer more investment competition to stocks while raising the cost of borrowing for corporations and households.

The yield on the US benchmark 10-year Treasury stands near its highest level in around 16 years on worries that the Federal Reserve will leave rates around current levels longer than previously expected.

Shares of tech and growth companies, which often have significant expected profit growth in the years ahead, tend to be hit particularly hard when yields rise because their future projected earnings are discounted more severely.

“Because [the megacaps] are more highly valued, that just means that they are going to be more sensitive to changes in real interest rates,” said Matt Stucky, senior portfolio manager at Northwestern Mutual Wealth Management.

Options markets show elevated concern among investors. Thirty-day implied volatility for the Nasdaq-100-tracking Invesco QQQ ETF – a measure of how much traders expect the shares to gyrate in the near term – recently climbed to 22, the highest since mid-April, according to options analytics service Trade Alert.

Still, strategists point out that the rise in implied volatility for tech stocks is no more than for the broader market.

That sense of complacency makes tech stocks vulnerable to increased volatility should market declines accelerate from here, said Chris Murphy, Susquehanna Financial Group co-head of derivative strategy.

To be sure, some megacap stocks have held up relatively well in the S&P 500's latest slide, including Alphabet, whose shares are down only slightly since late July.

The Nasdaq 100, a proxy for a broader sweep of big tech and growth stocks, has fallen roughly in line with the S&P 500 since late July and remains up about 35 per cent this year. It is down 7 per cent from its highs.

Because [the megacaps] are more highly valued, that just means that they are going to be more sensitive to changes in real interest rates

Matt Stucky,
senior portfolio manager, Northwestern Mutual Wealth Management

Investors also see other risks for megacap stocks.

A US antitrust lawsuit filed this week against Amazon created a “new line of worry in the megacap space”, said Rick Meckler, partner at Cherry Lane Investments in New Jersey.

And while optimism about increased use of AI applications has helped tech stocks this year, there is some question about the ultimate boost to profits, said Bryant Evans, portfolio manager at Cozad Asset Management.

“The whole promise of AI hasn’t … reached fruition yet,” Mr Evans said.