The stock market is close to correction levels

What if I told you that the fastest growing stock market in history is simply about a misunderstanding?

You’ve probably seen headlines like these:

Or this:

Doesn’t it seem like the stock market is flying record highs while the economy is in free fall? And at the same time, a record 50 million Americans are out of work?

It would. Because all the fuss about the comeback of the stock market comes on a misinterpreted term.

As I will show, where all these headlines refer to, is no longer the stock market as we know it. Most stocks have a long way to go to full recovery. And this confusion puts many investors in danger without even realizing it.

After all, what is the “scholarship”?

If you hear words like “the stock market” or “shares” in the media, they do not refer to every stock in America. They usually refer to the S&P 500 (SPX).

The S&P 500 is an index that tracks the performance of America’s 500 largest companies. The index contains 75% of all US equities and is considered the key to the total market.

This term has become so commonplace that it has become a synonym for the entire stock market. That’s why people throw it around senselessly when they talk about stocks.

So let’s take a look at how the index comes to the figure you see in the headlines.

In short, the index calculates the total performance of all 505 stocks it covers. But it is not as simple as adding the growth percentages and dividing by 505.

Each stock in the index has a “weight” based on the size of its business (known as market capitalization). The “heavier” the stock, the more its performance affects the index. For example, Apple
AAPL
, with a market cap of $ 1.7 trillion, has a 5.3X higher impact on index performance than Visa
V
with its $ 0.325 trillion.

This formula is meant to give us an accurate picture of how the whole stock market of America is doing. Problem is, it does not work today.

The S&P 500 no longer represents the stock market

The 505 shares in the index come from a range of sectors that once had a proportional weight in the index. From 2001 to 2019, the distribution by sector was more or less as follows:

But that is no longer the case. During the pandemic, investors flocked in large numbers to tech and tech stocks, capturing the S&P 500 big time – as you can see below:

Today, they make up more than 27.5% of the benchmark index. But if you add in Google (GOOGL), Amazon
AMZN
, and Netflix
NFLX
shares that are not rated as technical shares in the S&P – the share of the technology in the index swells to a staggering 36.6%.

That is the highest share of technical shares in the S&P 500. Ever. Even in the 2000s dot-com rage, tech stocks did not dominate the S&P 500 as they do now.

Tech was a ballistic force that drove the entire S&P 500

This year, the S&P 500 soared 50% of its lows, surpassing its Covid record. That has given investors the wrong impression that the entire stock market is booming. Reality is, most of this growth was driven by tech stocks.

Seven of the 10 S&P 500 toppers this year are tech stocks, including Nvidia
NVDA
(88% up), Paypal
PYPL
(88% up), and Amazon (AMZN) (86% up). Meanwhile, 63% of the shares in the index are down, according to CNBC.

And because tech stocks have a disproportionately higher weight than the rest of the stocks in the index, their performance has been greatly enhanced. This is how technical stocks grew into a ballistic force that pushed the entire S&P 500 to a historic record.

Take a look at this graph. It shows where the S&P 500 would be today if we included communications (Facebook, Google, and Netflix) and tech sectors – along with Amazon:

If it were not for tech stocks, the S&P 500 would be around 8.6% higher by my calculations. That’s still close to correction area.

Do not put your eggs in one tech basket

There are two problems with that.

First, the S&P 500 index gives many investors the impression that America’s shares are doing better than they are. But they are not.

Second, ETF funds that follow the S&P 500 are one of the most popular investments. They are also one of the go-to pension funds. In other words, there is a horde of Americans who rely financially on this index.

They put their money into the S&P 500 with the belief that they are well diversified. If in reality more than one third of this money goes to gambling on high-flying tech stocks.

Of course, tech stocks have been a huge investment so far. Covid has passed on a number of technical trends, such as online shopping. And a lot of money changed hands from “offline” stocks to tech stocks.

But this technical boom cannot go on forever. Trillion-dollar shares nearly doubling in half a year is not the norm for every imagination. Chances are high that tech stocks will take a breather somewhere in the line.

And with technical stocks accounting for a record 37% of the S&P 500, the pullback could drag the entire index down. As such, it would be wise to spread your eggs a little wider

You could look at classic anti-crisis investments like gold or blue chip stocks. Another way to limit your confidence in tech stocks is to switch to an ETF fund that tracks the S&P 500 Equal Weight Index.

(The largest ETF of its kind is Invesco S&P 500® Equal Weight ETF [RSP].)

Unlike the standard S&P index fund, this does not take into account the weight of the stock. That means an ETF fund that follows it will spread your investment over 505 shares in equal shares, regardless of weight.

This way, you invest in a more diverse basket of America’s top stocks without banking 37% of your money on tech stocks.

Set up your investment game

Every week I put out two stories to explain what is happening in the markets. Subscribe here to get my analysis and shares directly in your inbox.