The magnificent few

Like a Netflix show trying desperately to get renewed, the stock market delivered an unreasonable number of plot twists this week. Here’s how it played out:

• Tuesday: The S&P 500 and Nasdaq hit all-time highs, fueled by enthusiasm for AI and strong corporate earnings expectations.
• Wednesday: Stocks retreated as rising bond yields rattled investors.
• Thursday: A report on OpenAI’s revenue sent AI stocks tumbling, with Nvidia, Oracle, and CoreWeave among the casualties. The tech-heavy Nasdaq dropped 1.25%, its worst day since mid-August.

The deets: OpenAI disclosed roughly $50 billion in annualized revenue by September’s end, below the $68 billion it had previously signaled. That doesn’t inspire confidence, although the discrepancy largely came down to whether or not partner revenue was included.

A lopsided affair

The whiplash exposed a problem hidden beneath market highs: The S&P 500 isn’t nearly as diversified as its name suggests.

Although the index tracks hundreds of companies, because it’s weighted by market capitalization, the biggest stocks have the most influence. Thanks to narrow breadth, a handful of tech giants can keep the index climbing—even as much of the market struggles.

Case in point: When the S&P 500 hit its record Tuesday, just 46% of its stocks were trading above their 200-day moving averages, compared with a historical average of 76% during record highs. And when the index fell Thursday, roughly 66% of its stocks actually rose. In fact, for all the talk of bullishness, a MarketWatch analysis found that over 40% of S&P 500 stocks were in individual bear markets last month.

The culprit, to no one’s surprise, is AI. Investors are wildly throwing money at the tech, and AI stocks’ outsized influence on the S&P 500 has helped mask weakness elsewhere. Since September, tech stocks have gained roughly 10%, while sectors like real estate, financials, and materials have fallen as borrowing costs continue to rise.

Diversification nation

This week showed how quickly that imbalance can spell danger. With the index’s 10 largest constituents accounting for nearly 40% of its value, trouble for a few heavyweights can drag down the benchmark even when most stocks are doing fine, as we saw Thursday. A disaster larger than one startup’s revenue report could cause much more damage.

For investors, an S&P 500 fund may offer less diversification than it appears. The equal-weighted S&P 500—or diversifying across sectors—can offer a better picture of the market. Bank of America recently upgraded healthcare for its growth prospects, for example, while Morgan Stanley sees potential in industrial stocks after a recent selloff.

That doesn’t mean investors need to abandon AI altogether. But with the bull market turning four on Monday, it might be worth checking whether your portfolio has too many eggs in one very expensive basket.—SY