The Stock Market Is Near Correction Levels

What if I told you the fastest stock market recovery in history is just a misunderstanding?

You’ve probably seen headlines like this one:

Or this one:

Doesn’t it seem off that the stock market is blazing past record highs while the economy is in freefall? And at the same time a record 50 million Americans are sitting around without a job? 

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It should. Because all the fuss about the stock market’s comeback comes down to a misinterpreted term.

As I’ll show, what all these headlines refer to is no longer the stock market as we know it. Most stocks have a long way to full recovery. And this confusion puts a lot of investors at risk without their even realizing it.

What is the “stock market” after all?

When you hear words like “the stock market” or “stocks” in the media, they are not referring to every single stock in America. They are usually referring to the S&P 500 (SPX). 

The S&P 500 is an index that tracks the performance of America’s 500 biggest companies. The index contains 75% of all American stocks and is considered the key gauge of the overall market.

This term is so prevalent it has become a synonym for the entire stock market. That’s why people mindlessly throw it around when they talk about stocks. 

So let’s take a quick look at how the index arrives at the figure you see in the headlines.

In short, the index calculates the total performance of all the 505 stocks it includes. But it’s not as simple as adding up the growth percentages and dividing by 505.

Each stock in the index carries a “weight” based on its company’s size (known as market cap). The “heavier” the stock, the more its performance affects the index. For example, Apple AAPL , with its market cap of $1.7 trillion, has a 5.3X higher impact on the index performance than does Visa V with its $0.325 trillion.

This formula is supposed to give us an accurate picture of how America’s entire stock market is doing. Problem is, it doesn’t work today.

The S&P 500 no longer represents the stock market

The 505 stocks in the index come from a range of sectors that used to have a proportionate weight in the index. From 2001 to 2019, the breakdown by sector looked more or less like this:

But that’s no longer the case. During the pandemic, investors flocked to tech in droves and tech stocks hijacked the S&P 500 big time—as you can see below:

Today they make up over than 27.5% of the benchmark index. But if you add in Google (GOOGL), Amazon AMZN , and Netflix NFLX —stocks that aren’t labeled as tech stocks in the S&P— the tech’s share in the index swells to a staggering 36.6%.

That’s the highest share of tech stocks in the S&P 500. Ever. Even in 2000 during the dot-com craze, tech stocks didn’t dominate the S&P 500 as they do right now.

Tech was a ballistic force driving the entire S&P 500

This year the S&P 500 soared 50% from its lows, blazing past its record before Covid. That has given investors the wrong impression that the entire stock market is booming. Reality is, most of this growth was driven by tech stocks.

Seven out of the 10 S&P 500 top performers this year are tech stocks, including Nvidia NVDA (88% up), Paypal PYPL (88% up), and Amazon (AMZN) (86% up). Meanwhile, 63% of the stocks in the index are down, according to CNBC.

And because tech stocks have a disproportionately higher weight than the rest of the stocks in the index, their performance has been greatly amplified. This is how tech stocks grew into a ballistic force pushing the entire S&P 500 to a historic record.

Take a look at this chart. It shows where the S&P 500 would be today if we took out communication (Facebook, Google, and Netflix inside) and tech sectors—along with Amazon:

If it weren’t for tech stocks, the S&P 500 would be down around 8.6% from its highs by my calculations. That’s still near correction territory.

Don’t put your eggs in one tech basket

There are two problems with this.

First, the S&P 500 index gives a lot of investors the impression that America’s stocks are doing better than they are. But they are not.

Second, ETF funds that track the S&P 500 are one of the most popular investments. They are also one of the go-to retirement funds. In other words, there’s a hoard of Americans who are financially reliant on this index.

They are putting their money in the S&P 500 with the belief that they are well diversified. When in reality, more than one third of this money goes to gambling on high-flying tech stocks.

Of course, tech stocks have been a great investment so far. Covid has fast-forwarded a number of tech trends, such as online shopping. And a lot of money changed hands from “offline” stocks to tech stocks.

But this tech boom can’t go on forever. Trillion-dollar stocks nearly doubling in half a year is not a norm by any stretch of imagination. Chances are tech stocks will take a breather somewhere down the line.

And with tech stocks making up a record 37% of the S&P 500, the pullback could drag down the entire index. As such, it would be smart to spread your eggs a bit wider

You could look into classic anti-crisis investments like gold or blue-chip stocks. Another way to limit your reliance on tech stocks is to switch to an ETF fund that tracks the S&P 500 Equal Weight Index.

(The largest ETF of this kind is Invesco S&P 500® Equal Weight ETF [RSP].)

Unlike the standard S&P index fund, this one doesn’t take into account the stock’s weight. That means an ETF fund that tracks it will spread your investment over 505 stocks in equal parts, regardless of weight. 

This way, you’ll invest in a more diversified basket of America’s top stocks without banking 37% of your money on tech stocks.

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