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Investors face an interesting paradox these days: The world’s most widely followed stock market index, the S&P 500, appears expensive, no matter how you gauge such things; however, most individual stocks in the index look to be reasonably priced.

How do you explain this discrepancy? The S&P 500 seems pricey only because a handful of giant U.S. stocks are trading at lofty and perhaps unsustainable levels, according to Ian de Verteuil, head of portfolio strategy at CIBC World Markets. The vast majority of the market isn’t suffering from anywhere near the same euphoria, he argues in a thought-provoking report this week.

His report offers some fascinating numbers on the vast gulf that has opened up between the 10 biggest stocks in the S&P 500 and the remaining 490 in the market benchmark.

The biggest 10 stocks typically account for between 15 and 25 per cent of the S&P 500′s value. These days, though, they make up 30 per cent, the highest level in a quarter-century.

The S&P 500′s top-heavy tilt attests to the growing passion for a handful of already giant stocks. Investors are piling into these stocks and driving up their prices.

Granted, the biggest 10 stocks in the S&P 500 are usually somewhat more expensive than the index’s smaller fry. However, the Big 10 are not usually this much more expensive.

They now trade for more than 29 times their forward, or expected, earnings. This is nosebleed territory, far above historical norms. The lofty valuations suggest investors may be suffering from an outbreak of irrational exuberance.

In contrast, the remaining stocks in the index – the S&P 490, let’s call them – trade for around 16 times their forward earnings. That is pretty much smack dab where they have consistently traded over the past few decades. No exuberance there.

“Outside of the 10 largest stocks, the rest of U.S. equities are essentially in line with long-term valuation levels,” Mr. de Verteuil concludes. He predicts the stocks that make up the S&P 490 will perform better than the S&P 500 as a whole over the next few years thanks to their substantially lower valuations.

At the very least, his calculations should give investors second thoughts about piling into today’s hottest stocks.

The tech rally of recent months has focused nearly exclusively on seven huge companies that are expected to benefit from the artificial intelligence (AI) boom. These giants have all enjoyed massive gains this year. Each now ranks among the Big 10.

None of them is anywhere near cheap. The S&P 500 as a whole trades for about 19 times its forward earnings. By way of comparison, electric vehicle maker Tesla Inc. TSLA-Q goes for 61 times forward earnings and online retailer Inc. AMZN-Q for 60 times.

Nvidia Corp. NVDA-Q, the maker of computer chips and graphics cards, has tripled in value since the start of the year and now trades for 47 times forward earnings. Microsoft Corp. MSFT-Q (30 times) and Apple Inc. AAPL-Q (28 times) are also looking rather giddy.

Among the hot seven companies, only Alphabet Inc. GOOGL-Q, which has two share classes that both trade around 21 times forward earnings, and Meta Platforms Inc. META-Q (20 times) are more reasonably valued. But both are still significantly more expensive than the vast majority of the S&P 500.

To be sure, these seven companies could enjoy further gains in the weeks ahead, especially if the excitement around AI continues to grow. It’s not clear, though, that any of the hot seven have a guaranteed path to perpetual success.

The 1990s dot-com mania illustrates the perils of betting too much on any revolutionary technology. The speculators who bet big on the internet back then were entirely correct that the technology would transform society. They were mostly wrong, though, about who would reap the bulk of the long-run benefits. That confusion led to a lost decade for U.S. tech stocks.

Investors who want to avoid the possibility of a second dot-com-like disappointment may decide to sidestep the dubious allure of today’s AI titans. While it’s not possible to invest directly in the S&P 490, it is relatively easy to find strategies that downplay the 10 biggest stocks in the S&P 500.

One possibility is to invest in an equal-weight S&P 500, which holds equal amounts of each of the 500 stocks in the index. This structure means an equal-weight index is far less tied to the performance of the Big 10 than the standard S&P 500 index, which holds stocks in proportion to their market capitalizations and is therefore heavily biased toward the performance of the biggest stocks.

An even simpler idea is to look beyond the United States. Mr. de Verteuil argues that most global stocks are significantly less expensive than their U.S. counterparts. Many seem quite cheap.

Canadian stocks are a case in point. They are trading 10 per cent below their historically typical price-to-earnings levels, with enticing dividend yields to boot.

Investors should remember, though, that cheapness goes only so far. “This isn’t a ringing endorsement of stocks,” Mr. de Verteuil says of his findings. He acknowledges that if the global economy slides into recession, stocks everywhere will feel the pain. His point is simply that an expensive market benchmark doesn’t mean all stocks are equally expensive. Some might even be bargains.

Follow Ian McGugan on Twitter: @IanMcGuganOpens in a new window

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