Let's turn now to Christopher Dahlin, Invesco senior factor and equity strategist. Chris, thank you so much for joining us today.
Thanks for having me on, Kristen. It's nice to be here.
And thanks. Thanks for joining me. As I'm fighting a little bit of a cold. So I apologize if I cough in your ear. So I want to talk a little bit about market leadership. It's been fairly narrow lately. So how concerned should investors be about just how much of their return is dependent on such a small number of stocks?
Right now? I feel like we've been talking about this a lot. You know. Telling investors they need to diversify a little bit more.
Well, yeah. You know, it's interesting. It's kind of been a tale of two markets this year. For the first six months or so of the year we were having a very different conversations. We were seeing a large percentage of stocks in the S&P 500 actually outperformed the S&P 500, which had bucked the trend that we had seen in the previous few years.
But to your point, in the last 5 or 6 weeks, that trade has reemerged, the Mag seven, the hyperscalers, you know, the top ten companies in the S&P 500, leading market leadership, that that trade has reemerged. I'll say, based on our conversations with clients, I think part of the the reemergence of mega cap leadership is due toward is due to the risks of higher energy prices and higher interest rates, and these companies are very profitable.
Uh, positive cash flow. And so some of the broadening into some of the small and mid-cap names we saw at the beginning of the year, I think that's one of the reasons why we've taken a little bit of a breather from that. But I do think that a lot of the tailwinds that were powering the mid cap, small cap, the the broadening trade at the beginning of the year are still here, right?
We and mainly one of the ones is, is that, you know, the the AI and the productivity benefits that we're seeing from that, that that's that's real. Right. These companies have been investing heavily the last few years in artificial intelligence, and the belief is that eventually there are going to be some productivity benefits that are going to start to accrue downward below some of these mega cap names.
And so while there is a momentary, uh, there's a momentary level of risk here with higher interest rates and higher energy prices, I do think that a lot of the tailwinds are still. Are still at our backs here for some of these smaller mid-cap names.
So then I'm curious how much dispersion then, are you really almost seeing right now in the market, considering that we still do have that run on the small and mid caps, those tailwinds do still exist. And what you're saying about some of those tech stocks that have really been leading lately, again, fueled a lot by those energy prices, which again, everyone hopes it's caused by something external, which a lot of folks and a lot of investors essentially hopes goes away.
Right. That conflict in Iran?
Yeah, I mean, there's a couple of interesting things here. I will say, despite the emergence of the reemergence of this mega cap trade. It's interesting if you look at ETF flows, um, ETF flows are still telling us that investors do still see benefits in broadening out beyond these mega cap names. So if you look, for example, in the last five weeks, despite something like an equal weight index, the S&P 500 index underperforming the capitalization weighted S&P 500 by about 500 basis points.
If you look at flows into the S&P 500 capitalization weighted ETFs, the oh the spy spin, they're basically flat yet flows into equal weight. ETFs like RSP they're up $1.2 billion. And I think that probably speaks to what I was saying earlier about the the expectation that that fundamental benefits are going to begin to accrue downward.
If you look at second quarter earnings, for example, we did start to see that flow through to smaller companies. Normally in any given earnings quarter, maybe 70, 75% of companies, um, exceed analyst expectations in the second quarter. Almost 90% of companies in the S&P 500 had earnings that exceeded analysts expectations.
Every sector had positive earnings surprises you know. So this market is is is broadening from a fundamental standpoint beyond tech, beyond comm services. You know. And again that's not to be that's not to overlook the risks that are here with higher interest rates and higher energy prices. But I do think that there are telling signs that that fundamentally some of these benefits are beginning to broad.
And I think, you know, from an investor standpoint, from a flow standpoint, you know, I think that speaks to it as well.
It sounds like you're making the argument that this is the kind of perfect environment that equal weight really is benefiting from, or does benefit from.
It is, you know, it's there's a lot of ways, you know, if or if the thesis is correct, that eventually, you know, as you watch AI play out. Right. The early beneficiaries after ChatGPT in late 2022 were announced. The early beneficiaries, obviously, were the makers of the technology. The hyperscalers moved beyond to the the chip makers, to the memory makers.
But eventually the companies that that have invested heavily do need to begin accruing some of those benefits. Now, if that thesis holds true, you know, an economic growth has been pretty resilient. Despite these risks. You look at business investments been good, durable investments have been good.
Industrial production, manufacturing. The consumer has been pretty good. Retail sales have been pretty good. Obviously the flash PMIs last week were very robust and so this economy has continued to be pretty good. That has flowed through to better earnings down the cap spectrum. And so if one does subscribe to the belief that eventually these benefits will continue accruing downward, there is obviously a number of ways that one can position their portfolio to take advantage of that, just beyond kind of your mag seven exposure.
And one of those ways is equal weighting a portfolio that's naturally going to tilt the portfolio towards some of the smaller names in, in in the parent index. It's also going to tilt the portfolio away from some of the sectors that heavily dominate the capitalization weighted indexes like information technology and communication services.
And so for investors that, you know, do want to tilt that portfolio that way. Yes, equal weighting is a is is one simple way that investors can do that.
All right, Chris, we're going to have to bring you back to continue chatting about that, especially as we continue to see this play out inside of the market. Christopher Dahlin, senior factor and equity strategist for Invesco. Thanks so much for joining us.
