Nvidia (NVDA) Driving The S&P 500

Stocks opened mixed this morning (Dow +50 pts; SPX flat), and really haven’t moved much over the past couple of weeks. The rally is taking a breather for two reasons: weaker economic data and a pullback for Nvidia (NVDA). That said, market volatility is sort of muted and fear among traders—as measured by the VIX Index—is very low. The collective mood is cautiously optimistic as we approach the mid-year mark.

Economic momentum is slowing a bit. Citigroup’s US Economic Surprise Index, measuring the degree to which reports are coming in better or worse than expected, has fallen from +20 to -27 over the past two months. The latest Bloomberg News survey of economists shows slightly lower expectations for US economic growth this year (+2.3% vs. +2.4%). Retail sales eked out a .1% gain in May vs. April, and prior months’ data were revised lower. And this morning we learned that new home sales dived -11.3% last month.

None of this should set off alarm bells because we’re not seeing dramatic slowing. But economic activity is clearly normalizing. And this is what the Federal Reserve wants to see. Remember that the Fed is managing a balancing act in keeping interest rates high enough to tamp down inflation but not too high so that the economy suffers. Right now, numbers are moving in the right direction. Inflation ticked down to an annual rate of 3.3% last month vs. 3.5% in March. This is presumably due to slower growth. Fed officials seem to acknowledge this trend, but most investors don’t see them cutting interest rates just yet. CNBC reporter Steve Liesman said Fed officials have “nice words to say about recent inflation data…but none has really changed their outlook on policy.”

Meanwhile. corporate earnings growth is improving. And this—not Fed interest rate policy—is driving the stock market rally. According to Zacks Investment Research, S&P 500 earnings growth fell -1% last year, but is expected to grow 9% this year and more than 13% in 2025. Much of that growth is due to the AI boom and explains why select tech stocks like Nvidia (NVDA) are exploding higher.

This is a good news, bad news story. The good news, of course, is that AI is spurring business investment and propping up the stock market. This new technology does appear to be a compelling and will be implemented across just about every industry in coming years. And as I mentioned, AI is beginning to drive profit growth, especially in the tech sector.

The bad news is that AI has caused a near mania and is distorting the stock market and encouraging investors to disregard diversification and risk control in their stock portfolios. So far this year, the top seven stocks in the S&P 500—referred to as the “Magnificent 7”—are up 37%, whereas the S&P 500 excluding those seven stocks is up only 7%. The S&P 500 is market-capitalization-weighted, meaning that the largest companies (Microsoft, Nvidia, Apple, Amazon) have the biggest weights in the index. So at this point, the seven largest companies make up one-third of the entire index. That’s what we call concentration risk. By contrast, the Dow Jones Industrial Average is constructed differently and provides much less exposure to the few largest US companies. Not surprisingly, it is up only about 4% this year.

Obviously, no trend can last forever. Nvidia is up 200% in the last 12 months and that performance is unlikely to repeat. And while diversification is currently a dirty word, it will eventually reassert itself as wisdom. But in the meantime, the S&P 500 is being driven by that one market darling.