Market Impact of the "Magnificent Seven"
Many might think that 2023 was an outstanding year for stocks, but the reality is more nuanced. What if I told you that it was actually a barely decent year for stocks, and that they were saved from negative returns by a strong surge during the last few months in 2023? Despite the S&P 500 showing a nearly 21% gain through November and a nearly 11% increase through October, the majority of stocks struggled in the rising rate environment. An equally weighted portfolio of S&P 500 stocks would have seen a negative return through the end of October. The trend wasn’t limited to the S&P 500; U.S. small cap and mid cap stocks, emerging market stocks, and international small cap stocks all experienced negative returns in this period. International large cap stocks only managed a modest 2.2% gain. So, what was driving this disparity?
This uneven performance can largely be attributed to a group of dominant, high-flying mega-cap stocks in the United States, nicknamed the ‘Magnificent Seven.’ Initially dubbed the FANGS, and later FANTA, the composition of this group has evolved over time. These tech-leader superstocks, although widely known, cannot be mentioned by name without causing a compliance headache. They have been able to capture ever-growing segments of the global economy, and collectively soared by more than 100% in 2023 while most other stocks languished. Their dramatic outperformance over the past decade has led to these seven stocks now representing approximately 30% of the S&P 500’s size, despite being only 1% of the companies in the index. In 2023, they accounted for almost all the S&P 500’s performance.
What happens next?
This extreme concentration in both composition and performance leads to several questions, although most are outside the scope of this commentary. The question I want to focus on is what can we expect next? Will they grow to be 50%, 75%, or even 100% of the market? Or will the pattern observed in the past, like the late 1990s tech bubble and the dominance of the ‘Nifty Fifty’ in the 1970s, recur, where companies that were beneficiaries during periods of extreme concentration underperformed the broader market for a decade?
In a recent academic paper titled “Underperformance of Concentrated Stock Positions,” Antti Petajisto studied this phenomenon going all the way back to 1926. He found that, “Since 1926, the median ten-year return on individual U.S. stocks relative to the broad equity market is -7.9%, underperforming by 0.82% per year. For stocks that have been among the top 20% performers over the previous five years, the median ten-year market-adjusted return falls to -17.8%, underperforming by 1.94% per year. Since the end of World War II, the median ten-year market-adjusted return of recent winners has been negative for 93% of the time. The case for diversifying concentrated positions in individual stocks, particularly in recent market winners, is even stronger than most investors realize.”
Will history repeat itself, or is this time different? Only time will tell. One thing you can count on: CPC Advisors will continue navigating the complexities of the market using a diversified, long-term investment approach.
