Apple and Microsoft dominate the S&P 500

S&P 500 index is no longer a top-heavy gauge due to Apple Inc. and Microsoft Corp. holding more sway than they did in the past, leaving some investors on the edge of their seats over the index's increasingly top-heavy nature.

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After strong earnings reports from Microsoft and others helped fuel a rally in technology stocks, the world's two most valuable companies saw their combined weighting in the benchmark plummet to a record 14% this week. In fact, if you include Alphabet Inc., Amazon.com Inc., Meta Platforms Inc., and Nvidia Corp. in the S&P 500, nearly a quarter of every dollar put into the market is split among just six companies.

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"It is concerning that there is such a concentration of ownership in a small number of companies, especially since they are all in a very similar industry - the IT and communication services sector," said Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management. "There will be a period of time when this concentration will drive broader market performance until it doesn't."

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In the view of Tejas Dessai, an analyst at Global X ETFs, the growing influence of big tech in major indexes poses a significant risk to passive investors as they are at risk of being overexposed. "The fact that these businesses are some of the most innovative names in the technology world does help, however, since none of them is expected to see a secular decline anytime soon," he stated.

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It is estimated that Apple and Microsoft alone will have added over $1 trillion in combined market value in 2023, which is nearly half of the gains for the entire S&P 500 as a whole.

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In 2022, when soaring interest rates and slower growth sent valuations tumbling, the world's largest technology and internet companies lost their prominence when soaring interest rates and slowing growth sent their valuations tumbling. Although the stocks remain well below their peak levels, their outperformance relative to a market capitalization-weighted index this year has fuelled their rise to become one of the most influential benchmarks in the world.

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There is no doubt that the tech giants have benefitted from a flight to safety in the form of their cash-rich balance sheets amid the turmoil in the banking sector. Microsoft's quarterly profit and sales report, which was released earlier this week, proved to be a source of new momentum for the company as it beat Wall Street expectations. It was good news for both Alphabet and Meta as well, helping drive the tech-heavy Nasdaq 100 Index up 3.4% in the past two days, marking its best two-day gain in nearly three months and encouraging expectations for Apple's report next week.

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There is no question that the stock gains are pushing valuations to extreme levels, as Landsberg describes them. As of right now, Amazon is the market leader, trading at 38 times projected earnings, followed by Microsoft at 28 times, and Apple at 27 times. As of now, Google and Meta are trading below 20 times forward earnings, but they are rapidly catching up with their peers.

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With their ever-increasing weight index, some people are no longer going to be able to live as comfortably as they once did.

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“Investors should be aware that no matter which companies dominate an index, the more top-heavy the index becomes, the higher the level of risk it becomes for them as an investor,” said Dave Grecsek, managing director at Aspiriant LLC responsible for investment strategy and research.

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The stock of Cloudflare Inc. dropped as much as 27%, its biggest intraday drop in history, after the cybersecurity-focused software company cut its full-year guidance following the financial crisis, for the reason that a prolonged sales cycle has led to a material increase in sales cycles. It follows similar headwinds cited earlier in the week by another firm with a focus on security software, Tenable Holdings Inc.