The Stock Market is More Than Just the “Magnificent Seven”
In 2023, U.S. stocks posted a strong recovery from last year’s bear market. As I write, the S&P 500 is up over +20% for the year and is approaching the all-time high reached in December 2021.
Many pundits and analysts in the financial media are quick to point out, however, that the U.S. stock market’s returns have been mostly driven by just a handful of stocks, which many are deeming the “Magnificent Seven.” These are companies just about everyone has heard of: Apple, Alphabet (Google), Microsoft, Amazon, Meta (Facebook), Tesla, and Nvidia. Together, these seven stocks make up about 30% of the entire S&P 500’s market capitalization.1
To underscore how influential these seven stocks were on total index returns in 2023, consider that through the end of November, the S&P 500 was up a little under 20% while the Invesco S&P 500 Equal Weight ETF was up slightly less than 4%. The Magnificent Seven were largely responsible for this performance gap.
In fairness, the aforementioned seven stocks have delivered strong earnings growth over the past few years compared to the rest of the index, and profit margins are also well ahead of other companies (in aggregate) in the index. Indeed, the Magnificent Seven’s profit margins are 19% compared to the 9.8% profit margins for the rest of the S&P 500. Forward-looking earnings expectations for the Seven are also far higher than the rest of the index, with 17% long-term earnings-per-share (EPS) growth expected compared to 9% for the remaining 493 companies.
To put it simply, strong earnings and profits get rewarded in the stock market.
But this doesn’t mean investors can just load up on seven stocks and expect to outperform going forward. Experienced investors know that leadership changes hands in the stock market often. What outperforms one year may – and perhaps is even more likely to – underperform the next. Technology’s big run in 2021, for example, was followed by steep declines in the sector in 2022. Outsized gains were followed by outsized losses.
I would also add that the risk/reward profile of the Magnificent Seven stocks became less attractive with such strong performance in 2023, in my view. Both valuations and expectations for future earnings growth have become quite elevated, which creates challenges for future returns. Remember, stocks tend to move most when reality is better than expectations. And if expectations for these seven companies are very high, it could also mean they’re more susceptible to falling short.
I think it’s also important to point out that the recent decline in bond yields over the past few weeks has resulted in a much broader stock market rally, with 2023’s underperforming sectors becoming outperforming sectors. I’ll give you two examples. The S&P 500 real estate sector has been an underperformer in 2023, largely due to rising interest rates. But as pressure on long rates eased over the past few weeks, the S&P 500 real estate sector has powered higher, rising +12% in November alone – its best monthly performance since 2011.
Regional banks are another example of an area of the market that was battered earlier in the year but has posted a sharp rally since the end of October. The KBW Regional Banking Index is up over 20% just in the last month-and-a-half, as investors cheered falling interest rates and the possibility of rate cuts in the new year. The stock market is far more than just the Magnificent Seven.
Bottom Line for Investors
While it is true that the Magnificent Seven has been critical drivers of total return in 2023, I don’t see it as a case for narrowing a portfolio’s focus to just a handful of stocks. As the business cycle evolves, areas of the market that have lagged in recent years – like small-cap stocks, for instance – could be the areas that perform the best going forward. The Magnificent Seven’s stellar performance in 2023, in other words, should not influence you to narrow your portfolio but instead to diversify it even more.
Disclosure
1 Wall Street Journal. December 11, 2023. https://www.wsj.com/finance/rise-in-stocks-bonds-crypto-gold-683f0e91?mod=djemMoneyBeat_us
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