Hope for the transformative power of technology has been behind much of the S&P 500's rally this year. And tech will be key in pushing the index 5,000 points higher—making stocks worth owning over safer assets, according to DataTrek Research.
The Magnificent Seven of the Tech Sector
The tech sector's Magnificent Seven, namely Apple, Amazon.com, Google parent Alphabet, Facebook parent Meta Platforms, Microsoft, Nvidia, and Tesla, have been the main driver for the stock market's 12.2% gain in 2023. Bulls argue that artificial intelligence is only in the early stages of boosting productivity and profit. Furthermore, consensus earnings estimates for big tech have been climbing, as disruptors reap the benefits of their innovation.
Beyond Macro Factors
However, the market is already pricing in a Goldilocks outcome for the broader economy—one that most strategists wouldn't have predicted at the start of the year. Continued growth, cooling inflation, and smooth Federal Reserve execution are expected. Therefore, it will take something beyond macro factors to propel stocks higher and attract investors amidst towering bond yields that offer stiff competition.
Bonds vs Stocks
With the 10-year Treasury yielding 4.7%, there's certainly an argument for owning bonds. Investors might be tempted to go all-in on them—or even just hold cash—given the high interest rates. However, they should bear in mind that stocks will likely outperform in the long run. According to Mark Haefele, UBS chief investment officer of Global Wealth Management, "Cash is not an attractive long-term investment."
But with virtually zero-risk Treasuries sporting elevated yields, the S&P 500 would need to more than double over the next decade—to above 10,000—to compensate investors for the risk of owning equities, as stated by DataTrek Research co-founder Nicholas Colas.
In conclusion, while the transformative power of technology has driven the stock market's recent rally, there are factors to consider when investing in stocks compared to bonds. The tech sector's Magnificent Seven has been instrumental in propelling the market's gain, but it will take more than macro factors to sustain this momentum. Wise investors should carefully weigh the potential risks and rewards, especially against the backdrop of elevated bond yields.
The Road to 10,000: The Power of Tech and Innovation
By Teresa Rivas
With the 10-year Treasury's yield at 4.7% and the equity risk premium for U.S. large-cap stocks calculated at 4.5%, expert Aswath Damodaran from New York University concludes that stock investors should expect a minimum compounded annual return of 9.2% over the next decade. According to this analysis, if the S&P 500 does achieve a 9.2% annual growth rate, it will reach an impressive milestone of 10,000 by 2033.
Reaching such heights won't be an easy feat, as noted by experts. Over the past 10 years, S&P 500 companies' earnings have compounded at an average annual rate of 6.3%, with varying levels of performance each year. Considering that earnings already sit near record highs, it is likely that valuations will need to expand in order to propel the index to 10,000. This is where innovation plays a crucial role.
In the quest for 10,000, productivity-enhancing technologies like generative AI hold immense promise for boosting U.S. corporate profits, according to experts. Technology will play a pivotal role in achieving this ambitious goal.
"Since we cannot solely rely on earnings growth to surpass the required rate of return above risk-free Treasuries, valuations must expand to attain this objective," concludes expert Teresa Rivas. "This will hinge on a number of disruptive and highly profitable companies scaling their businesses and earning outsized valuations."
As demonstrated by the success of the Magnificent Seven and Big Tech over the past decade, investors do not necessarily need a vast array of stocks to generate long-term gains. However, the more disruptive companies in the mix, the better.
In line with this perspective, Thomas Mathews, Senior Markets Economist at Capital Economics, argues that the stock market's upward surge heavily hinges on the performance of the tech sector.
"If significant gains are to be made, they will likely arise from factors beyond economic resilience," Mathews explains. "One such factor could be the enthusiasm surrounding emerging technologies, such as AI or superconductors, which have the potential to bolster equity valuations."
In other words, the work of the tech sector is far from over, even after witnessing this year's remarkable rally.