Tech Stock Surge: Is Now the Time to Diversify Your Portfolio?

Buy low, sell high! That’s a popular motto when it comes to investing in stocks. In practice, attempts to time the market’s peaks and valleys usually fail to outperform a simpler buy-and-hold approach. That’s why our view “time in the market” (not timing the market) is essential to building wealth in the stock market over the long term. But what if one sector or one security performs so well that it becomes a significant portion of an investor, retirement plan, or foundation’s assets? Is it time to “sell high” to maintain a diversified portfolio? Many clients are asking us that question after the recent surge in technology stocks.

Running the numbers

Since Nvidia claimed the top spot as the world’s largest company with a market capitalization of more than $3.3 trillion on June 18, 2024, the stock suffered a 26% drop (peak to trough, ending August 5, 2024). The decline wiped out a whopping $800 billion of market capitalization.  To put that number in perspective, $800 billion is more than the market cap of Eli Lilly, the 9th largest company in the S&P 500.

The run up in Nvidia’s stock prior to the decline is even more staggering. Consider this, Nvidia was valued at a little more than $400 billion a couple of years ago and $1 trillion a year ago. Shares are up 144.52% year-to-date (through July 17, 2024) and have surged more than 1,000% since October 2022.² In addition, when Nvidia hit the $3 trillion market cap milestone in early June 2024, the company passed Apple and is now firmly behind Microsoft, securing its spot as the second-most valuable public company.³

Nvidia has been the top performer but isn’t the sole tech stock to post impressive returns over the past two years. From lows in October 2022, Meta Platforms, the parent company of Facebook, has surged nearly 500%, Microsoft has doubled in value, and the tech-heavy Nasdaq 100 is up 85%.⁴

Market impact

The massive rallies in a handful of large cap tech stocks means that they now represent a substantial percentage of the S&P 500. The index is a capitalization-weighted index of 500 companies and the Magnificent 7 stocks (Microsoft, Meta, Amazon, Tesla, Apple, Nvidia, and Alphabet) account for more than 31% of the index’s value.⁵

Because many mutual funds, exchange traded funds, and other asset managers track the S&P 500 index, the ongoing ascent of the Mag 7 also means that a lot of retirement plans, mutual funds, and other investors are exposed to those large cap names. The three largest — Microsoft, Nvidia, and Apple — are in the technology sector, which is by far the largest group within the S&P 500 today and accounts for 31.5% of the index’s value.⁶ While Tesla and Amazon are considered consumer discretionary stocks, Meta and Alphabet fall into the communication services sector within the S&P 500.

The impressive gains in the large cap names that dominate the S&P 500 is also why many active investors (hedge funds, option overlay strategies, value investing, etc.) have failed to keep pace with passive investment strategies (buying and holding funds that track the S&P 500) over the past two years.⁷ In my opinion, the rally in the Mag 7 is why it’s been difficult to match the S&P 500’s 52.9% gain since its October 2022 lows and nearly 15% advance so far in 2024; any approach that has been underexposed to the Mag 7 and the technology sector in general has been at a huge disadvantage.

When to diversify

Sector allocation is something we consider for our client portfolios. While we do own the Mag 7 stocks, our sector weightings are currently more balanced than the S&P 500’s heavy tilt towards technology. In our view, the potential risks of being heavily weighted one sector outweigh the potential rewards.

The surge in some individual stocks has also resulted in highly concentrated portfolios for many, including for those who work for the large technology companies that have led the market’s recent advance. After seeing their employer stock or option grants increase exponentially in value in a short period of time, some are asking us if it’s time to diversify by “selling high” and investing elsewhere.

As a fiduciary, we’re obligated to act in our client’s best interest. While risk tolerance is a key consideration, having a disproportionate percentage of a portfolio in one sector or company typically has large potential rewards, but it can result in sudden unexpected losses in wealth (as shown by a three-day $430 billion loss in Nvidia’s market cap).

Consider Boeing. From its lows in early 2009 to its highs a decade later, there seemed to be no stopping the stock. Shares surged from less than $30 to more $440, or 1,300%. But then the tides turned; good headlines turned to bad. The stock has experienced five years of roller coaster action and is now down nearly 60% from 2019 highs. For investors holding a highly concentrated position, especially employees of the company who are near or at retirement, a 60% drop could represent a substantial loss of wealth.⁸

How to diversify

Since the concentrated position may hinder the portfolio’s future of the portfolio, diversification is an important step. There are multiple methods to help reduce the impact on the portfolio, including:

• Gifting shares to family
• Selling the shares
• Hedging the position
• An Exchange Fund
• Charitable donations
• Charitable remainder trust

We discuss the methods above, and more, in more depth in our “The Role of Concentrated Positions in a Well-Diversified Portfolio” article. We encourage you to read it as well.

Bottom line

The ongoing run up in some of the large cap technology stocks reflects the view that these companies — with their strategic advantages, ability to scale, strong financials, and hefty cash flows — are in the best position to capitalize on the latest wave of innovation that’s in full swing. Our approach seeks to take the noise — and emotions — out of the decision-making process. Instead, we make stock selections based on unbiased data, long-term goals, and the client’s tolerance for risk.

¹Nvidia sees over $500 billion wiped off value after shares slide—the biggest 3-day value loss for any company in history.  June 25, 2024. Christiaan Hetzner, Fortune.

²MarketWatch

³Nvidia passes Microsoft in market cap to become most valuable public company, June 18, 2024, CNBC.

⁴MarketWatch

⁵35% of the S&P 500 Is Concentrated in the “Magnificent Seven.”, July 9, 2024, The Motley Fool.

⁶NVIDIA Takes The Throne: Is This A Tech Bubble? June 24, 2024. Bill Stone, Forbes.

⁷Wall Street’s Smart-Trade Brigade Thrashed Again on Stock Boom. June 21, 2024. Denitsa Tsekova, Bloomberg

⁸MarketWatch