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The recent dip in AI-related stocks serves as a sharp reminder of how much the U.S. stock market depends on the tech sector.
On Tuesday, the S&P 500 and Nasdaq Composite experienced their largest single-day drops in almost a month, dragged down by a sharp tech selloff. While these indexes bounced back a bit on Wednesday, tech stocks still faced some continued losses.
Tech is the dominant sector in the S&P 500, making up about 36% of the index—more than during the dot-com bubble, according to S&P Dow Jones Indices’ Howard Silverblatt.
Including companies outside the tech sector, such as Alphabet, Amazon, Tesla, and Meta, tech-related stocks make up nearly half of the S&P 500.
With so much tied to the AI sector, investors worry that any downturn in this area could ripple across the broader market, given the heavy tech influence in key indices.
The Risk of Overreliance on AI and Tech Stocks
Walter Todd, Chief Investment Officer at Greenwood Capital, pointed out that the S&P 500’s heavy reliance on AI and tech stocks presents a potential risk. A setback in AI could hurt both individual stocks and the entire market.
Tech shares have fallen over 3% since last week, with key players like Palantir Technologies and Nvidia experiencing significant losses.
Investors believe the recent pullback may be a healthy reset after a period of strong growth. However, concerns about an AI stock market “bubble” make even slight declines a point of major focus.
The CEOs of major banks like Morgan Stanley and Goldman Sachs recently warned that market drawdowns could be near, citing high stock valuations. The S&P 500’s price-to-earnings ratio is at 23, above its 10-year average of 18.8, with tech’s P/E ratio of 32 significantly higher than its historical average of 22.2.
Tech’s Continued Market Dominance and Strong Profits
Despite the recent decline, tech has been the star performer of the current bull market, which has been running for more than three years. While the S&P 500 has gained 90% over this period, tech stocks have surged by 186%.
In 2023, tech outperformed all other S&P 500 sectors, rising 27%, compared to the broader market’s 15% gain. This has led to tech’s share in the S&P 500 growing from just under 33% at the start of the year to 36% now. The next biggest sector, financials, accounts for just 13%.
Matt Maley, Chief Market Strategist at Miller Tabak, emphasized that if tech stocks experience sustained declines, the indexes will likely follow suit.
Stronger Financial Fundamentals in AI-Driven Tech
The strength of tech stocks, especially those driving the AI boom, is supported by robust financials. In Q3, tech is expected to generate around 25% of the S&P 500’s total earnings, according to LSEG’s Tajinder Dhillon.
Unlike the tech stocks of the dot-com era, companies at the forefront of AI are generally stronger financially. Scott Wren of Wells Fargo pointed out that these companies are now generating substantial cash flows, making them more stable than those from the early days of the internet.
Wren added that the tech giants’ strong investments in AI continue to be a major driver of market performance. However, he cautioned that any hint of weakness in AI growth would likely cause an immediate market downturn.
