Strong U.S. growth is prompting investors to scoop up a broader set of stocks, rather than just the handful of giant technology companies that drove indexes to record heights.

With heavyweights including Apple and Tesla sinking this year, a larger group of companies has helped power recent gains. The equal-weighted S&P 500, which measures each company equally rather than by its market capitalization, rose to a record this past week. Almost one-fifth of the stocks in the index hit new 52-week highs on a recent day, the largest share since May 2021, according to research by Bespoke Investment Group.

The shift signals Wall Street’s embrace of the idea that the U.S. economy has weathered the worst of this cycle’s interest-rate increases. That clears the way for potentially large gains in all kinds of assets, including smaller and riskier stocks. The S&P 500 is up about 33% in the past 12 months, off less than a percentage point from its record close on Thursday.

That’s good news for investors. A broadening rally mitigates fears that big tech companies’ dominance—and investors’ enthusiasm for the prospects of artificial intelligence—concealed underlying weakness that left stocks vulnerable to a reversal.

“With inflation coming down and the Fed no longer fighting you, it’s just a better long-term case for risky assets,” said Joseph Amato, chief investment officer of Neuberger Berman.

Investors will get a fresh look at stocks’ prospects from the latest reading of the consumer-price index coming Tuesday, along with earnings reports due this week from companies such as Oracle, Kohl’s and Adobe. 

Rising borrowing costs and an anticipated slowdown helped concentrate stock gains over the past couple of years. The bulk of U.S. companies struggled to improve their bottom lines in 2023. But behemoths such as Nvidia and Microsoft—members of the so-called Magnificent Seven—earned more on their war chests of cash than they spent paying to service debt issued during the pandemic refinancing spree.

Corporate profits are expected to continue being supported by strong productivity and fiscal spending. In December, Federal Reserve officials projected the economy would grow at an inflation-adjusted rate of 1.4% this year. An Atlanta Fed model is tracking toward 2.5% for the first quarter. The Fed is signaling that interest rates will likely fall later this year.

Tech stocks are still up double-digit percentages in 2024, while rate-sensitive shares such as utilities and real estate are relatively unchanged. But industrial and financial-services shares, tied more to the outlook for growth, have advanced at least 7%.  

At the same time, the Russell 2000 index of smaller companies, which tend to get most of their revenue from inside the U.S., has climbed 27% off its October lows. Investors’ worries about borrowing costs and slowing growth had driven small-cap stocks into a bear market when the Fed began ratcheting up interest rates. 

Among small-caps, the biggest gainers are companies riding waves of investor fervor. Fueled by bets on artificial intelligence, chip maker Super Micro Computer has posted a 301% gain that lifted it out of the Russell 2000 and into the S&P 500. Bitcoin buyer MicroStrategy is up 126%, and meme stock Carvana has climbed 61%. 

Wall Street typically rejoices when a rally expands to include more parts of the market, considering it a sign that stocks have more room to run. But huge run-ups in speculative corners give some cause for caution.

Companies in the S&P 500 are currently trading at roughly 21 times their expected earnings over the next 12 months. That is ahead of the long-term average price/earnings ratio around 18, and approaching the 24 hit during stocks’ postpandemic rally.

Analysts’ earnings forecasts could be difficult to meet as well, said Jawad Mian, founder of Stray Reflections, a macroeconomic advisory firm. Wall Street expects S&P 500 companies’ earnings to grow 11% this year and a further 14% or so in 2025, according to FactSet. When the economy grew more than 6% last year, S&P 500 companies’ earnings rose about 2%—and U.S. growth is expected to weaken this year.

“We are reaching the constraints of this bull market,” Mian said. He expects smaller companies to outperform the broader market as the Big-Tech-driven rally loses steam. 

The potential for a revival in inflation is also concerning investors, particularly after the most-recent CPI reading interrupted months of encouraging data showing price pressure fading. If inflation fails to fall toward the Fed’s target and growth stays strong, rates might remain higher for longer.

One thing that has hamstrung smaller stocks is their impending need to refinance. Companies in the Russell 2000 tend to have higher leverage, their debt relative to cash on hand or earnings. And when excluding financial companies, nearly half of the index has floating-rate debt such as bank loans on its balance sheet. That compares to about one-tenth of the benchmark S&P 500.

“Everyone thought we slayed the beast of inflation,” said Neuberger Berman’s Amato. “Outside of large-cap stocks with fortress balance sheets, higher rates will have an effect.”

That’s one reason why Randy Gwirtzman, portfolio manager at Baron Capital, avoids companies with lots of leverage. Among his largest holdings are shares of DraftKings, a stock he bought more of during the fourth quarter.

“Investors have become enamored with Big Tech stocks—they’ve left small-caps by the wayside,” he said. “Economic upturns are particularly exciting for smaller companies.”