Over the last couple of years, a few stocks, known generally as the Magnificent Seven, were responsible for most of the appreciation in the major stock market indexes. There’s too much risk in these stocks and the major indexes, observes fund expert Bob Carlson, editor of Retirement Watch.
Lower inflation, stable interest rates, and solid economic growth should boost prices in the broader stock market as the year progresses. As such, I recommend two funds that will benefit from a broader bull market.
Since most of the stocks in these funds have lagged the major indexes during the last few years, they’re selling at much lower valuations. The two funds have higher margins of safety and carry less risk in case the markets turn south.
The first fund is an ETF that follows an equal-weighted version of the S&P 500, Invesco S&P 500 Equal-Weight (RSP). The S&P 500 is capitalization weighted. The larger a stock’s market capitalization (its stock price times the number of shares outstanding), the greater the fund’s percentage of the index is.
Currently, the 10 stocks with the largest capitalizations are 32% of the index. Microsoft (MSFT) is over 7%, Apple (AAPL) is almost 7%, and NVIDIA (NVDA) is over 4%. More than 30% of the S&P 500 is in technology.
The capitalization-weighted S&P 500 is a big bet that the stocks that outperformed the last few years will continue to outperform. RSP is much more balanced. Each stock is about 0.25% of the fund, and the 10 largest positions are only 3% of the fund. A little over 15% of RSP is in technology.
Another way to benefit from a broader bull market with less risk is an ETF that invests in an index of small company stocks, iShares Russell 2000 (IWM). As the name says, the ETF attempts to track the Russell 2000, an index of smaller company stocks.
Despite the name, the fund recently was invested in 1,968 securities. Only 4% of the fund was in the 10 largest positions, and only one holding was more than 1% of the fund.
I like small stocks at this point, because their returns the last few years have been well below those of large company growth stocks. In fact, the return gap between the two types of stocks is at or near a historic high.
I expect a return to the mean in which smaller company stocks close some of that performance gap. Top sectors in the fund were technology, health care, industrials, financial services and consumer cyclical.
