How the rise of Big Tech is shaping the future of US equity markets 

THE US equity market has grown by leaps and bounds since the beginning of the 21st century, riding on the wave of structural megatrends. But over the past few years, the rapid digitalisation of the global economy has taken things to the next level.

Just look at the largest publicly listed companies in the world today. Among the top 10, eight hail from the US. The two exceptions are Saudi Aramco and Taiwan Semiconductor Manufacturing Company.

Among the eight companies, six are Big Tech firms. The sheer dominance of the companies in equity markets underscores the pivotal role US tech companies play, not just in the US, but in the global economy as well.

The S&P 500 index has also evolved substantially over the past few decades. In the years prior to the dotcom bubble, tech stocks accounted for less than 10 per cent of the S&P 500, while the biggest companies were mainly from the consumer, energy and industrial sectors.

Fast forward to today, the tech sector accounts for a staggering 32 per cent of the index, displacing traditional sectors such as the ones mentioned above. But that is not all. If we were to include other large-cap companies that are not officially classified as tech – such as Amazon, Meta and Alphabet – the proportion of these companies rises to about 50 per cent.

The emergence of Big Tech companies as a dominant force in the US and global equity markets reflects the longer-term megatrends towards digitalisation and innovation. We believe these companies will continue to drive market performance and shape the future of the global economy for many years to come.

US: capital of innovation

So why does the US have an unusually large number of mega-cap tech firms? The answer lies in a combination of factors, including a robust ecosystem for innovation, a culture that encourages entrepreneurship, well-developed capital markets and strong intellectual property (IP) protection.

The US is the third most innovative country in the world, trailing behind Switzerland and Sweden, according to the Global Innovation Index which ranks 132 economies based on 80 factors, spanning areas such as education, infrastructure and the political environment.

But in reality, it should hold the No 1 spot. That is because the majority of global innovation comes from the US, even though the country makes up less than a quarter of global GDP. The US is home to several world-renowned universities such as MIT (Massachusetts Institute of Technology) and Harvard, which produce cutting-edge research and foster innovation. America’s college system also produces one of the most highly skilled workforces in the world, which its companies can tap into.

Aspiring entrepreneurs also benefit from the US’ well-developed capital markets, which make the country one of the best places on earth to secure funding for new ideas. The US currently leads the world in terms of venture capital (VC) investment, with US-based firms receiving the lion’s share of global VC funding.

It also ranks highly when it comes to IP protection, which can help companies to safeguard their competitive advantage. At the same time, strong IP protection standards deter copying technologies and promote research and development, which ultimately raise the level of innovation across the country.

Together, these factors have helped to produce numerous industry leaders which hold dominant positions in both the US and international markets. This is most evident in the tech sector, where Big Tech firms often dominate entire industries. Going forward, the US will likely continue to be one of the most innovative countries on earth, with its tech sector at the forefront.

US stock valuations

The higher weighting of tech stocks has had a profound influence on the earnings and valuations of the S&P 500 index. Over the years, the average forward PE ratio of the S&P 500 over various five-year periods has increased, from roughly 14 times back in 2009-2014 to nearly 21 times today. This is no coincidence, and most likely driven by investors paying higher multiples for tech stocks.

But are these multiples justified? The short answer is likely yes.

Given their high-growth nature, tech stocks tend to command higher valuations than the broader market, and rightfully so, because of their stronger earnings growth. Between 2013 and 2023, earnings of US tech companies grew at a compound annual growth rate of 11 per cent, compared to just 7 per cent for the broader of the market.

Going forward, consensus estimates suggest that the sector is likely to see even stronger earnings growth of as much as 25 per cent year on year, again leading the broader market by a considerable margin. If tech companies manage to deliver, or perhaps even exceed these expectations, their valuation multiples are likely to expand further.

All in all, as the world becomes increasingly digitalised and more technology megatrends take hold, investors who have long seen tech as a tactical rather than a core allocation within their portfolios may want to reconsider, given the sector’s increasingly central role in driving economic growth and shaping the future of global equity markets.

The writer is a portfolio manager of the research and portfolio management team at FSMOne.com, the B2C division of iFast Financial. The latter is the Singapore subsidiary of iFast Corporation.