Nvidia's $3 trillion surge: what’s in store for the US stock market?

In mid-June, Nvidia briefly became the world’s largest company, hitting a market capitalisation of over $3 trillion*. It was the culmination of a record-breaking rally in the shares, which had more than doubled for the year to date. It then saw a brief but savage sell-off, with the chip designer losing 16% in just a couple of weeks*.

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The trajectory of Nvidia neatly encapsulates the problems of the US market as the country celebrates Independence Day. It is the top-performing stock market, bar India, for the year to date, with the S&P 500 up 15.5% since the start of the year**. However, those gains have been relatively narrow. They have been even more narrow than they were in 2023, when the Magnificent Seven – Alphabet, Microsoft, Apple, Nvidia, Meta, Tesla, and Amazon – dominated. This year, Apple and Tesla have dropped off that illustrious list.

Research from JP Morgan shows that close to 90% of the price returns delivered by the S&P 500 over 2023 can be attributed to the performance of these seven stocks***. It says: “In a year where the S&P 500 returned 24%, the median stock in the index returned a less impressive 8.2% in comparison. The S&P 500 now has a higher level of concentration than was experienced during the 2000s tech bubble.”

Nvidia continues to perform extremely well. Its most recent earnings report showed revenues up 262% from a year ago****. There is no doubt that the market has persistently underestimated the demand for its products in the wake of the AI revolution. The difficulty is that each earnings report pushes future expectations even higher. JP Morgan points out that the largest ten stocks in the S&P 500 are trading on a multiple of 30x forward earnings, compared to just 18x forward earnings for the remainder of the S&P 500***.

The big question – as it has been for some time - is whether this dynamic in the US market will change. Gary Robinson, manager on the Baillie Gifford American fund says: “Nvidia remains the only game in town in chips. I don't think that will last forever. But for the time being, if you want to build a large cluster, you need to buy Nvidia chips. It is still probably under-appreciated on AI just how much more computing power is needed when going from one generation of large language models to the next. We’re talking a 10x increase in scale.”

He points out that Nvidia, along with other AI-focused businesses such as Amazon have a captive customer base, a direct relationship with their customers, and a proprietary dataset that they’re able to leverage. He adds: “One of the lessons that we’ve learned over the last couple of decades of investing in US growth stocks is that the best companies often turn out to be a lot better than even the most bullish of assumptions.”

That said, he recognises that investors need discipline on valuation. “The question that we’re asking with Nvidia is, is there a path to a 2.5 times return over the next five years with a greater than 20% probability?

Mid and small-caps have started to catch up with their peers in other regions, but have remained stubbornly behind their large and mega-cap peers in the US. For the year to date, the USA SMID cap index is up 4.5%, while the wider MSCI USA index is up 10.9%^. This gap has persisted even in the very short-term.

There are plenty who believe that this part of the market is a more fertile hunting ground. Cormac Weldon, manager of the Artemis US Smaller companies fund says: “US smaller companies' valuation discount relative to larger companies is a well-known phenomenon and remains intact. For the fund, we are not struggling to find opportunities, in fact quite the opposite. We are seeing a range of sectors still trading at depressed levels and we see many companies with unique drivers to their growth that we believe will persist.”

It is a sentiment echoed by Neil Birrell, Premier Miton’s chief investment officer. “We believe the background is in place for a substantial long-term outperformance of smaller companies over large. It’s happening in some regions now and we are of the view the US will join the party, which will carry on for some time.” Premier Miton runs the £1.6bn US Opportunities fund on the Core Selection. The fund has delivered strong performance in spite of not holding the mega-caps have having a greater focus on mid and smaller companies than its peers.

JP Morgan’s view is that there is often a ‘catch up’ phenomenon following periods of high concentration and wide valuation dispersion in the market. In these instances, smaller, less expensive stocks tend to outperform. “In the five years following an elevated valuation dispersion between the largest ten stocks and the rest of the S&P 500, the equal-weighted S&P 500 tends to outperform the market cap-weighted index. That is, smaller stocks generally do better than the mega-caps following elevated concentration.”

Another option for investors looking to diversify away from the mega-caps is a US equity income fund. These tend to focus on US blue chip companies. The JPM US Equity Income fund, for example, has Wells Fargo, ConocoPhillips and Bank of America among its top holdings^^. It is heavily weighted to financials, healthcare and industrials^^.

These areas are more likely to do well if there is a slow down in growth. This is not the way the US economy has been heading, but higher rates can have a lagged effect. Inflation has proved more persistent than many expected, and interest rate cuts look increasingly unlikely. There is a potentially disruptive election due in November. These could all bring about a change of mood in the US market.

The choice facing investors is tough: stick with the tried-and-tested mega-caps, move into unloved and undervalued small and mid-caps, or look for a defensive strategy with a US equity income fund. Given the uncertainty of the environment, exposure to all three may be a sensible diversified approach.

*Source: Financial Times, 24 June 2024
**Source: FE Analytics, total returns in pounds sterling, 2 January 2024 to 3 July 2024
***Source: JPMorgan Asset Management
****Source: Nvidia, First Quarter Fiscal 2025, 22 May 2024
^Source: MSCI index factsheet, 28 June 2024
^^Source: fund factsheet, 31 May 2024

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.