Fact: It Isn’t Just Seven

Editors’ Note: MarketMinder doesn’t make individual security recommendations. The below merely represent a broader theme we wish to highlight.

To hear many pundits tell it, the story of the upturn since October 2022 isn’t the tale of a young bull market. No, it is just a figment, a house of cards propped up by a handful of stocks—the so-called “Magnificent Seven.”^[i] Without them the young bull market is allegedly flimsy to the point of being non-existent. That meme has been all over the place this week, with some on Finance Twitter questionably noting the other 493 S&P 500 stocks are down absent those 7 (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta). But, friends, here is the simple truth: The rally is much broader, and even long stretches of large-cap leadership aren’t unusual or bearish. Let us dive in.

And let us start with a picture. Exhibit 1 shows the equal-weighted S&P 500 index’s returns relative to the market cap-weighted version. When the line is rising, the equal-weighted index is outperforming, which means large cap is underperforming (since it is represented more heavily in the cap-weighted version). As you shall see, large stocks have long stretches in both the sun and the rain, and it is normal for leadership shifts to happen during a bull market.

Exhibit 1: Large Cap Leadership Isn’t Weird

Source: FactSet, as of 12/5/2023. S&P 500 equal-weighted and cap-weighted total returns, 12/31/1989 – 12/4/2023. Indexed to 1 at 12/31/1989. The time period is the equal-weighted index’s full history.

There is one weird thing about large cap’s leading this year: It is happening early in a bull market. Usually, small and value stocks lead early, tied to the bounce effect from the prior bear market (what gets hammered the hardest usually bounces the fastest and highest). That can last a couple years as they reap big earnings growth from cost cuts made during the bear market. Then, when they have wrung out all they could and revenue growth becomes a bigger driver, large and growth stocks usually take the reins. Their leadership can last for years as investors slowly return to the market and gravitate to the biggest, most stable companies with famous brand names and diverse revenue streams, driving P/E ratios higher as investors get increasingly comfortable with paying up for future earnings.

Last year’s bear market was unusual, though, in that large growth stocks bore the brunt, while small value didn’t take its usual outsized punishing. Therefore, large growth enjoyed the bounce effect, then benefited from slow-growth concerns. This might not last indefinitely, and we can see a scenario where value regains leadership in the foreseeable future—and it wouldn’t automatically require a fresh bear market to kick it off. It could happen if sentiment got too hot toward growth. Or if the global economy reaccelerated in a big way. We aren’t assigning probabilities to this for now, but it is worth bearing in mind as a counterpoint to all the talk that stocks will roll over if the Magnificent Seven stop looking so magnificent relative to everyone else.

Or, actually, not quite everyone else. Because the thing is, the rally is actually a lot broader than it gets credit for. Through yesterday’s close, 310 S&P 500 constituents had positive year-to-date returns.^[ii] Four in addition to Meta and Nvidia had triple-digit returns.^[iii] Another seven joined Tesla in the 75% - 100% category.^[iv] Microsoft and Amazon had 26 other bedfellows in the 50% - 75% bracket.^[v] Apple and Alphabet? The 48^th and 50^th best of the lot, respectively.^[vi] So, yes, a bit top-heavy. But nowhere near to the degree headlines allege, and the statements about 493 stocks being “down” if you strip away the best performers is, well, wrong or cherrypicked at best. If you have a diversified portfolio that stretches well beyond those seven companies and across the universe of sectors and countries—which we reckon you should for risk management—then you have likely done fine this year.

So while Tech and the Tech-like parts of Communication Services are having a great year, they aren’t solely responsible for this young bull market. A lot of companies and industries are doing the heavy lifting, and the foundation is plenty firm.