By Amrith Ramkumar 

Technology companies are set to end the year with their greatest share of the stock market ever, topping a dot-com era peak in the latest illustration of their growing influence on global consumers.

Companies that do everything from manufacturing phones to operating social-media platforms now account for nearly 40% of the S&P 500, on pace to eclipse a record of 37% from 1999, according to a Dow Jones Market Data analysis of annual market-value data going back 30 years. Apple Inc., which became the first U.S. company to hit a $2 trillion market capitalization earlier this year, accounts for more than 7% of the index on its own. Early last month, it accounted for 8% of the S&P, the largest share ever for any stock in data going back to 1998.

Despite a recent pullback in popular tech stocks like Apple and Netflix Inc., many of these companies still number among the market's leaders for 2020, powering the S&P 500 to a nearly 8% gain for the year and keeping it near all-time highs during the coronavirus-induced economic slowdown. Tech stocks lifted markets early last week before dragging them down later in the week, highlighting their sway over the major stock indexes.

Trends like remote work and cloud computing are driving growth at these firms, helping tech companies expand their businesses at a time when many are struggling. Yet the concentration of gains in a narrow group of companies concerns many investors, who worry that stocks are too dependent on the sector and that a significant pullback in a few names could bring down markets.

Previous peaks in a sector's influence over the S&P 500 have preceded selloffs. The tech sector tumbled after the dot-com bubble burst. Banks' influence over markets peaked in 2006 ahead of the financial crisis, and energy stocks slid after hitting a new high in their share of the index in 2008.

Few analysts say tech stocks are as overvalued as they were two decades ago, with sturdy earnings growth and near-zero interest rates justifying much of the group's recent ascent. But many investors are bracing for more volatility in a sector that has risen remarkably quickly and pulled the rest of the market along with it.

"We've had a mandated digital lifestyle," said Alison Porter, a portfolio manager focused on the sector at Janus Henderson Investors. She remains confident in the biggest technology companies because of their reliable growth and prominence with people staying home during the pandemic.

Investors this week will monitor the next round of third-quarter earnings from companies including Netflix, as well as the latest figures on weekly jobless claims to gauge the health of the economy.

Because Congress hasn't passed additional stimulus measures, many traders remain hesitant to favor parts of the market that are more directly tied to economic growth. That also held true throughout the slow but sturdy expansion that ended earlier this year. While data show the tech giants employ fewer workers than some other previous market leaders, they do invest heavily in their businesses and allow other firms and consumers to buy and sell goods and services more efficiently.

Howard Marks, co-founder of investment giant Oaktree Capital Group LLC, said in a recent memo to clients that measures of how expensive tech stocks are relative to current profits could actually understate the potential of these companies because they spend so much to drive their rapid growth.

Analysts estimate the tech sector's share of S&P 500 corporate profits could reach about 36% this year, FactSet data show. The information technology sector has a price/earnings ratio of 28 based on the group's profits from the past year, compared with a ratio of 24 for the S&P 500. Communication-services firms trade at 25 times earnings, while Apple, Microsoft Corp., Facebook Inc. and Alphabet Inc. have valuations in the mid-30s. Netflix's ratio is about 90, while Amazon.com Inc.'s is roughly 130.

Even for more expensive internet companies, many investors are willing to pay for their rapid growth.

"They have received an added boost over the last 10 years because the broad economic backdrop has been lackluster," said David Lebovitz, a global market strategist at J.P. Morgan Asset Management. He is recommending clients favor companies within the sector that aren't as expensive as the most popular internet stocks.

At the same time, frenzied trading in the most popular internet companies remains a concern for many market watchers. Some of that activity has taken place in options tied to tech stocks. Options grant the holder the choice to buy or sell a stock at a certain price by a specified date. Banks and other firms that sell options to investors often then hedge against prices going up or down by trading tech investments themselves, a force that can exacerbate volatility. Japanese conglomerate SoftBank Group Corp. was a big buyer of tech-stock options earlier this year.

The analysis of tech's concentration in the S&P 500 is based on companies in the information technology and communication-services sectors. Notably, that group excludes Amazon, the e-commerce giant that is in the consumer discretionary sector. Including Amazon, which has a market value around $1.6 trillion, would make the tech sector's sway over markets even bigger.

Because the S&P 500 is weighted by a company's market value, the biggest internet firms have overshadowed declines in several sectors this year. In another illustration of the group's strength during the pandemic, the S&P is outpacing a version of the index that gives every stock an equal weighting by nearly 10 percentage points this year, a gap that would be the highest since the late 1990s.

"The longer this backdrop continues, the further they're going to pull away from the pack," said Amanda Agati, chief investment strategist at PNC Financial Services Group, which is favoring companies more tied to remote work and learning recently like technology, health-care and consumer-staples firms.

Amazon and other large internet companies have come under increasing regulatory scrutiny in recent weeks, with a Democratic-led House of Representatives panel recently finding that Congress should consider forcing the tech giants to separate their dominant online platforms from other business lines.

Few analysts expect the biggest tech firms to soon be broken up and regulatory actions are often slow to play out, but many investors think regulation could be another source of volatility in the weeks ahead.

"The only thing that really makes me nervous as a tech bull is the likelihood of government intervention," said Jacob Walthour, CEO of Blueprint Capital Advisors. Still, he recommends clients favor technology stocks, e-commerce companies like Amazon and electric auto maker Tesla Inc. because of their growth potential.

Write to Amrith Ramkumar at amrith.ramkumar@wsj.com

 

(END) Dow Jones Newswires

October 16, 2020 20:41 ET (00:41 GMT)

Copyright (c) 2020 Dow Jones & Company, Inc.
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