It is no secret that a handful of large stocks have been driving the strong performance of the market this year, but the extent to which the S&P 500 index is top-heavy is worth closer examination. In fact, it might even be a macroeconomic issue at this point.
These stocks, dubbed the “Magnificent Seven” – Apple, Alphabet, Amazon.com, Meta Platforms, Microsoft, Nvidia, and Tesla – have played a pivotal role in pushing the S&P 500 more than 5% higher this year, following a solid finish to 2023. The investor frenzy surrounding artificial intelligence, in particular, has propelled chip maker Nvidia and other AI-exposed companies like Meta to gain double-digit percentage points in just a matter of weeks.
The sheer market capitalization of these stocks has grown at an alarming pace compared to the other 493 names in the S&P, resulting in a highly concentrated index. In fact, Deutsche Bank strategist Jim Reid notes that the index is now at its most concentrated level in at least the last century. To find a similar scenario where so few stocks held such high weightings in the broader market, one would need to go back to the bubble of 1929.
The concentration of stock market value at these levels extends beyond a mere anomaly and warrants macroeconomic consideration. The fate of these few companies has a substantial impact on overall market sentiment, according to Reid.
“The performance of the Magnificent Seven stocks in recent months, and indeed years, has undeniably influenced the macro environment,” Reid wrote in a note on Tuesday. “Without their dominance, the U.S. stock market and global sentiment would have a very different outlook. Consequently, their future performance is likely to have significant implications for the majority of global assets moving forward.”
In fact, the combined market capitalization of these Magnificent Seven stocks alone makes it the second-largest national stock market in the world, according to Deutsche Bank, and it is twice the size of Japan’s market, which ranks fourth. It’s worth noting that the market caps of Apple, Microsoft, the stock markets of Saudi Arabia, and the U.K. are all fairly similar in size as well.
The Magnificent Seven: A Focus on Concentration and Growth
As the Federal Reserve considers significant interest rate cuts this year, the concentration of the Magnificent Seven may continue to grow, capturing the attention of investors even more.
According to Deutsche Bank, stock market concentration tends to increase when bond yields are lower. With the expected rate cuts from the Fed, the benchmark 10-year U.S. Treasury yield is predicted to fall, potentially boosting the market caps of the Magnificent Seven. These stocks, known for their growth potential, are valued based on future earnings. Lower yields typically enhance the present value of future cash flows, and investors are already anticipating strong earnings from companies like Nvidia that outpace the broader market.
Deutsche Bank identifies several factors that either support or challenge the continued growth of the Magnificent Seven. On one hand, there is optimism surrounding their global reach, impressive innovation power, earnings surpassing those of many large countries, and strong U.S. support. Additionally, the potential of artificial intelligence (AI) is still in its early stages. On the other hand, pessimism arises from concerns over regulatory actions against Big Tech, public scrutiny of AI, geopolitical risks, and the possibility of rapid tech changes that could turn against these highly valued companies.
Regardless of whether one views them as compelling investment opportunities or significantly overvalued, there is no denying the influence of the Magnificent Seven across various asset classes.
