While many investors have sold tech stocks on concerns about the sector's outlook, Goldman Sachs has undiminished enthusiasm for investing in these companies. "Investors should continue to reward secular growth as the U.S. economy slowly decelerates from its current 4% pace toward trend. Although tech sector valuations stand near cycle highs, they remain low relative to long-term history," Goldman says in its latest Weekly Kickstart report. Additionally, Goldman challenges the notion that investments in tech stocks are dangerously overcrowded. Although tech remains a hedge fund and mutual fund favorite, first quarter position filings showed that tilts in the sector are smaller now than they were in 2016 and 2017.

Narrow Market Breadth

Goldman acknowledges that market breadth has been very narrow so far in 2018, with only 10 stocks delivering 62% of the total return (dividends included) registered by the S&P 500 Index (SPX). Of these, at least 7 are in the technology sector, and the number jumps to 9 out of 10 if you add Amazon and Netflix, which are classified by many investors as consumer discretionary stocks.

Stock Ticker % of S&P % of S&P YTD Return
Amazon.com Inc. AMZN 3% 15%
Microsoft Corp. MSFT 4% 12%
Alphabet Inc. GOOGL 3% 8%
Apple Inc. AAPL 4% 8%
Netflix Inc. NFLX 1% 4%
Mastercard Inc. MA 1% 3%
Visa Inc. V 1% 3%
Adobe Systems Inc. ADBE 1% 3%
Boeing Co. BA 1% 2%
Nvidia Corp. NVDA 1% 2%
Total For Top 10   18% 62%

Source: Goldman Sachs; total return (dividends included) calculations as of July 26.

Goldman notes that in periods of low overall returns for the S&P 500, "it does not take very many stocks to lift the index by a small amount." They calculate that the entire tech sector, plus Amazon and Netflix, has delivered 76% of the year-to-date (YTD) total return for the S&P 500. Looking ahead, Goldman projects 19% EPS growth for the tech sector in 2018, and 11% in 2019, while the consensus estimates call for 21% and 9% growth rates, respectively.

Sparked by Facebook Inc.'s (FB) disappointing earnings report last week, the Nasdaq 100 index of big tech stocks fell for the third day in a row on Monday, the first trading day after Goldman's report appeared. But the index was rebounding solidly through noon on Tuesday.

Negative Indicator

The bad news, Goldman says, is that "narrow breadth has signaled below-average prospective returns in the past, but currently remains above levels that have historically been warning signs." They add that previous narrow bull markets since 1990 have preceded economic slowdowns, and also usually were followed by large market declines "when investors lost confidence in the increasingly expensive handful of crowded market leaders."

But 2018 Is Different

In the past, however, concentrated market leadership typically corresponded with increasing earnings concentration, per Goldman. By contrast, they observe that "the earnings environment today appears healthy and broad-based." They base this comment on data showing that the consensus EPS growth projection for the S&P 500 is 9% for 2019, while the increase for the median S&P 500 stock is even higher, at 10%. Moreover, while the top 10 stocks listed above are generating about 20% of total S&P 500 earnings, this is in line with the figures for the last few years and slightly below the 21% average for the last 30 years, Goldman adds.

As of the report date, exactly half the S&P 500 companies had reported second quarter earnings, and 60% beat consensus estimates by at least one standard deviation, putting this earnings reporting season on track to be one of the two best, in this regard, in at least 20 years. Overall, 79% of those reporting so far have beaten earnings estimates by any margin. Noting that tax reform is a big factor in the earnings increases, Goldman adds that revenues are running slightly above estimates. Among tech companies reporting second quarter results so far, 89% have delivered positive earnings surprises, while 71% have produced surprises of one standard deviation or more.

Market Resilience

As evidence of broad-based market resilience, Goldman cites the case of Facebook Inc. (FB), whose shares plunged by 19% on July 26, following a disappointing earnings report. On the same day, they note that the rest of the S&P 500 rose by 10 basis points, 7 of the 11 S&P sectors posted gains, and shares of fellow FANG member Alphabet rose by 75 basis points. (For more, see also: FANGs Overvalued Despite Recent Drop: Paul Meeks.)