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.