Market Extra: Left behind by 2023 stock-market rally? Use this kind of ETF to play catchup, says BofA.

Investors may be better off owning the equal-weighted version of the S&P 500 index in the second half of 2023, after the popular stock-market gauge soared on narrow breadth during the first six months of the year, according to BofA Global Research.

“Extreme bearishness into 2023 led to a big rally” in the first half, said BofA equity and quant strategists led by Savita Subramanian in a note this month. “Despite some improvement in sentiment, Wall St. is still largely cautious on equities, which suggests the pain trade is still to the upside.”

Just 25% of stocks outperformed the S&P 500 in the first six months of 2023, marking the narrowest first-half breadth ever, according to the BofA note. The S&P 500 Equal Weight index
SP500EW,
-0.83%
widely lagged over that period, although it outperformed in June.

“We expect breadth to continue to broaden out as seen in June, and expect the equal-weighted index to outperform the cap-weighted index” in the second half of 2023, the strategists said.

The S&P 500’s gains this year have been driven by megacap stocks such as Apple Inc.
AAPL,
+0.25%,
Microsoft Corp.
MSFT,
+0.92%,
Google parent Alphabet Inc.
GOOG,
-1.39%

GOOGL,
-1.35%,
Amazon.com Inc.
AMZN,
-1.55%,
Nvidia Corp.
NVDA,
-0.51%
and Tesla Inc.
TSLA,
-2.10%
and Facebook parent Meta Platforms Inc.
META,
-0.81%.

These seven names make up more than a quarter of the capitalization-weighted S&P 500 index, “meaning that together they influence index returns more than any other sector save information technology,” DataTrek Research co-founder Jessica Rabe said in a note emailed Thursday. The tech sector has a 28.2% weight, she said.

Shares of chipmaker Nvidia have skyrocketed around 187% this year based on Thursday afternoon trading levels, while Meta has soared more than 144% over the same period and Tesla has surged about 125%, FactSet data show, at last check.

The S&P 500’s biggest weight, Apple, has jumped around 47% so far this year as of Thursday afternoon, for a market value of around $3 trillion.

During the first six months of 2023, the S&P 500 rose 15.9% for its strongest first-half of a year since 2019, according to Dow Jones Market Data. That’s after tumbling last year the most since the financial crisis of 2008, as the Federal Reserve’s interest rate hikes in 2022 broadly pummeled stocks and bonds as it sought to cool the economy in an effort to bring down still elevated inflation. 

Read: Recession canceled? U.S. stock market ‘pretty frothy’ after S&P 500’s strongest first half since 2019.

Meanwhile, the Invesco S&P 500 Equal Weight ETF
RSP,
-0.82%,
which tracks an equal-weighted index of S&P 500 companies, has seen around $4.5 billion of inflows over the past month, according to FactSet data as of July 5. Shares of the ETF rose 5.9% during the first half of the year. 

On Thursday, the U.S. stock market traded lower as Treasury yields jumped after a report from payroll-services company ADP showed the private sector added far more jobs in June than economists expected. The S&P 500
SPX,
-0.79%
fell 0.8% Thursday, while the Dow Jones Industrial Average
DJIA,
-1.07%
fell 1.1% and the Nasdaq Composite
COMP,
-0.82%
dropped 0.8%.

“ADP reported strong gains in June although the ADP metric is not always a reliable indicator for month-to-month changes within the official labor report,” cautioned Jeffrey Roach, chief economist for LPL Financial, in emailed commentary Thursday. The U.S. government will release its employment report for June on Friday. 

“Unless Friday’s report is much weaker than expected, the Fed will not likely change its plans to increase rates during the next regularly scheduled meeting later this month,” said Roach.

Meanwhile, the group of seven megastocks in the S&P 500, known as Big Tech, could still push the index higher from here, although they appear richly valued, according to the DataTrek note.

“Cost cutting, a resilient US economy, and enthusiasm about generative artificial intelligence have largely driven Big Tech’s rally this year,” Rabe wrote.

“US Big Tech is showing better upside earnings revisions and expected 2024 earnings growth than the broader US equity market,” she said. “These names have rich valuations, so their reported results and guidance during the upcoming earnings season will prove important in showing just how much gen AI can be to their top and bottom lines in the coming quarters.”

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