As the S&P 500 rises higher, I’m buying cheap FTSE 100 stocks

Major US indexes just rocketed as concerns about inflation subsided. Here’s why I’m ignoring that and targeting cheaper FTSE 100 stocks.

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The S&P 500 surged almost 2% yesterday (14 November) after cooler-than-expected US inflation data boosted hopes that interest rates might now have peaked. Unfortunately, that didn’t translate into a big rise in FTSE 100 stocks. In fact, the blue-chip index eked out a measly 0.2% gain.

This latest stateside rally means the S&P 500 is now up around 17.5% in 2023. Meanwhile, the FTSE 100 is marginally down this year.

A not-so-magnificent concentration

The valuations of many US stocks were already looking stretched heading into November. Now the price-to-earnings (P/E) ratio of the benchmark index is around 22. That’s basically double the FTSE 100’s multiple.

Of course, comparing the two indexes is a bit like comparing apples to oranges.

Fast-growing tech giants dominate the US market and they naturally attract higher multiples. The FTSE 100 is packed with dividend-paying banks, insurers, miners and energy stocks. These sectors rarely attract high valuations even at the best of times.

But one worry I have with the S&P 500 is the ever-increasing concentration at the top. The largest two stocks (Apple and Microsoft) now represent a combined 14.5% or so of the whole index. This is the highest weighting for any two companies since 1980.

The ‘Magnificent Seven’ stocks — Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla — are currently trading at an average P/E ratio of 42. And they have a combined index weighting of around 30%.

I fear that if two or three of these outsized companies disappoint investors with their future growth outlooks, we might quickly see a market correction (a decline of between 10% and 20%).

Backing up the truck

By comparison, I reckon FTSE 100 stocks offer a much more attractive starting point. And because of this cheapness, I’d say there’s less chance of a rapid Footsie correction (though that can’t be ruled out).

To take advantage, I’ve been loading up on shares of insurer Legal & General (LSE: LGEN). The firm has a solid balance sheet, generates plenty of cash and possesses an excellent dividend record.

Due to its weak share price, the company’s dividend yield has been in the 8% to 9.5% range all year. This has allowed me to beef up my passive income portfolio, which I haven’t finished doing yet.

Naturally, this doesn’t mean the payout is guaranteed. The global economy remains weak and even Legal & General could one day lose its status as a Dividend Aristocrat.

For the potential high-yield reward, though, I’m content to take on the risk.

Investing through a jittery market

Lately, some stocks have been getting absolutely crushed following disappointing news.

For example, spirits behemoth Diageo fell 15% on 10 November after delivering a shock profit warning. This was its worst share price fall since 1997.

While this update wasn’t great, and may trigger City analyst downgrades, I doubt it’s the worst Diageo development in more than a quarter of a century. So I duly topped up my holding at £27 per share.

Now, with many stocks, a lower share price may well be justified. Every case is different. But in some instances, I think the market is overreacting right now. And this could offer up some great long-term bargains for my portfolio.

As Warren Buffett said: “Be greedy when others are fearful“.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Ben McPoland has positions in Alphabet, Apple, Diageo Plc, Legal & General Group Plc, Nvidia, and Tesla. The Motley Fool UK has recommended Alphabet, Amazon, Apple, Diageo Plc, Meta Platforms, Microsoft, Nvidia, and Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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