Stock market strain possible in September, according to Morningstar, amid potential risks, despite tech sector's growth surge

Dominic Pappalardo, Chief Multi-Asset Strategist at Morningstar Wealth, has issued a warning about the high concentration of tech stocks in the S&P 500. According to Pappalardo, the top-10 stocks are likely to react together, given their interconnected nature.

Eight of the top ten companies in the S&P 500 are tech or tech-related, with the eight largest being Alphabet, Nvidia, Microsoft, Meta, Amazon, Apple, and Broadcom. These companies, often referred to as the "Magnificent Seven" tech giants, have a significant influence within the index due to their market capitalization.

Pappalardo notes that a high concentration in a portfolio can be risky, as it offers more upside potential but also brings a higher downside risk. He suggests diversifying a portfolio heavily invested in tech stocks by adding international stocks, small-cap stocks, and the healthcare sector.

Tariffs have contributed to the rising inflation data and continue to impact the economy, Pappalardo said. Inflation has proven to be stubborn, with the Consumer Price Index rising 2.7% year-over-year in July, and the core Personal Consumption Expenditures rose 2.9% in July.

Pappalardo predicts that a market correction could occur in the near future, as the S&P 500 is near record highs. He cites weak employment growth and persistent inflation as potential threats to the rally. If one or more of the top tech stocks report weak results, it's likely that all eight will fall and be sold simultaneously, having a disproportionately large impact on the index.

However, Pappalardo doesn't believe a recession is imminent. He states that if the Fed is cutting rates because it believes the economy is weak, it's not a good sign. If inflation remains high, the Fed will likely keep rates high, which will slow economic activity. The Bureau of Labor Statistics' payroll report on September 5 will provide more insights into the health of the labor market.

By at least one measure, the U.S. stock market is more concentrated in its largest titles than ever before. The ten largest stocks in the S&P 500 now account for about 40% of the leading index, which is an all-time high. Morningstar, a financial firm, warns that a high concentration in tech stocks poses risks, in case profits disappoint.

The Federal Reserve resumed its rate cuts in September, which was welcomed by investors. However, Pappalardo states that rate cuts can only boost stocks if the labor market remains stable. If the Fed believes the economy is weak, it may indicate a potential slowdown.

In conclusion, while the tech giants dominate the S&P 500, their high concentration poses risks. Investors are advised to diversify their portfolios to mitigate these risks. The health of the labor market and the Fed's response to inflation will be key factors to watch in the coming months.

Stock market strain possible in September, according to Morningstar, amid potential risks, despite tech sector's growth surge