Updated June 4, 2024 at 12:04 am ET

The biggest stocks—which include Apple—have been propelled in part this year by excitement about artificial intelligence. Photo: Eric Thayer/Bloomberg News

Big Tech stocks aren’t just dominating the market. They’re also hiding just how scared investors are that the Federal Reserve will keep rates higher for longer.

The average stock in the S&P 500 is hurt more by rising yields—and helped more by falling yields—than any time this century. Yet the S&P itself is far less affected by the outlook for interest rates, because the Big Tech stocks that make up so much of the standard, value-weighted index are insulated from the Fed by their enormous cash piles.

The biggest stocks—Nvidia, Microsoft, Apple and Alphabet—have been propelled in part this year by excitement about artificial intelligence, as I discussed last week. But the highly unusual divide in both valuation and sensitivity to interest rates between the S&P and its average constituent shows just how those big stocks are skewing measures used by “macro” investors who focus on the economy and the Fed.

The valuation split is clear. Divide the market into tenths by size, and the valuation of the groups rises fairly steadily as company value rises. Valuation isn’t as vertiginous, either: The median stock in the S&P trades at 18 times forward earnings, against more than 21 times for the Big Tech-dominated index. (To be clear, that still isn’t cheap by historical standards.)

The sensitivity to interest rates can be gauged by comparing the ordinary S&P 500, which gives more weight to larger companies, and the equal-weighted version, which treats tiddlers the same as titans to measure the average stock. The ordinary S&P is up over 10% this year through Friday, while the equal-weighted version is up less than 5%.

The link to bond yields is also split, with the average stock more strongly linked to bond yields—rising when they fall, and vice versa—than any time since 1999 over a 100-day period. The gap between this correlation and that of the ordinary S&P, which has a much weaker link to Treasury yields, is unprecedented in data back to 1990.

Aside from AI, I think this is best explained by corporate profits and interest rates, and to a lesser extent concern about the economy.

The Big Tech stocks that dominate the market sit on huge cash piles, while the biggest companies chose to lock in low interest rates for a long time by refinancing their bonds before the Fed began raising rates in 2022. Smaller companies tend not to have cash piles on which to earn fat savings interest and have more need to issue bonds to raise cash. The smallest don’t even have access to the bond market, one reason the Russell 2000 index of smaller companies has lagged so far behind the S&P this year, eking out a gain of just 1.6%.

Investors concerned about higher-for-longer interest rates have thus avoided the lower rungs of the S&P, even as the biggest stocks perform well. On days when bond yields fall—as on Thursday, when they plunged—the rate-sensitive smaller stocks typically do well.

But the S&P itself is dragged around by the huge weight of its dominant Big Tech stocks, so on Thursday the index had a bad day even as only 139 stocks fell. The opposite happened on Friday, when bond yields fell sharply and smaller S&P members rose more than 1.5%, while the index as a whole rose only half that as its biggest members held it back.

The big-vs.-small-stocks phenomenon reflects the same disconnects we see in the broader economy. If the Fed is going to wait longer before cutting, as several policymakers have suggested in recent weeks, there will be more pressure on the parts of the economy already struggling with high rates. Poorer and younger borrowers are already feeling the pressure of higher rates. This drags on growth: Economic data have come in below forecasts for a month or so, according to Citigroup’s economic surprise index. Big Tech sales shouldn’t be touched by a slowdown unless it gets really bad, unlike mainstream retailers, financial firms and goods producers.

The oddity about the market’s reaction this year is that it is almost exactly the opposite of what happened in 2022. Then, Big Tech stocks plunged as investors marked down their heady valuations, dragging the S&P down 19% over the year. Meanwhile the average stock was down just 13%, as smaller, lowly valued companies were regarded as less reliant on future profits that are worth less in a world of higher rates.

Why the difference? The AI excitement offsets the valuation hit. The rate shock this year—from expecting six Fed cuts to just one or two—is a different scale to 2022, when rates soared from zero to 4.5%. And investors have woken up to the long-dated debt and cash hoards that shield so many of the biggest stocks.

Investors outside the Big Tech sector are right to worry about higher rates. For those looking for bargains, the high valuation of the S&P hides the fact that its smallest 50 members are almost as cheap, at a median 15 times forward earnings, as the index as a whole was at the nadir of the Covid-19 panic in 2020.

If rate cuts do come to pass, the little guys should finally get the chance to put Big Tech in the shade.

Write to James Mackintosh at james.mackintosh@wsj.com