It’s already February and Dry January is a distant memory. And like most, you’re working toward your 2024 financial goals. When it comes to money and markets, this year gives us a backdrop of lower inflation, potentially lower interest rates, and positive momentum in both stock and bond markets from 2023. Stocks continued this rally in January with the S&P 500 +1.6% and Nasdaq +1.0%.
By now, you’ll have likely heard of the “Magnificent Seven” (Mag 7) stocks — Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla — that together contributed more than half of the S&P 500’s 26% return last year, and about a third of its +1.6% return so far this year. In fact, they collectively make up close to 30% of the overall index, a notable increase over the historical average closer to 20%.
This also happened at a time when no one expected it. The economic outlook to start 2023 wasn’t favorable for tech stocks; Mag 7 stocks were down more than ~50% in 2022, and they even ended up earning less in 2023 than the next largest 42 companies which equates to the same value as these seven behemoths. Fundamentals did improve for this bunch in 2023, but there’s also a lot of promise for future growth from AI built into these stock prices.
Sources: Capital Group, LSEG. Next 42 companies represent stocks following the Magnificent Seven, ranked by market capitalization, with the above stocks topping the list. Sales are the net sales (or revenues) of the relevant item reported in the last 12 months. Profit is represented by the trailing 12-month operating profit. As of December 31, 2023.
This outstanding performance by such a small, concentrated group has left investors with a lot of questions for 2024. If you didn’t own these names last year, you missed out. Should you be buying them now if you don’t own them? And if only a few companies carried the market last year, is the market rally really sustainable?
Is bad breadth really that bad?
Stock market breadth simply measures how concentrated (or not) the returns from the market have been. Since last year’s rally was carried by only a few, it had bad market breadth. That led to a lot of articles, like this one, questioning the rally’s sustainability. How sustainable is a rally dominated by a select few, and does it signal broader economic troubles if most companies aren't thriving?
Looking at history provides clarity on the first part. Over the last decade, the top ten stocks in the S&P 500 consistently accounted for over 30% of market returns in eight out of ten years. This pattern suggests that concentration is typical, and doesn't necessarily undermine the sustainability of the market rally.
Furthermore, while a more diverse rally with a broader range of companies and sectors would be more ideal, the current trend doesn't necessarily foretell trouble. Instead, it might offer an opportunity, especially if other economic indicators such as GDP growth, unemployment, and inflation remain positive. Signs of market breadth expanding and including more companies and sectors are starting to emerge, and earnings forecasts for the broader market in 2024 also indicate improvement compared to the Mag 7.
Sources: LPL Research, Bloomberg.
What if you missed out?
Missing out last year hurt. But you weren’t alone. Almost two out of every three professional US large cap money managers underperformed their benchmarks last year because of this phenomenon. And while market returns are typically driven by the top stocks, what we haven’t explored yet is if those top stocks remain the same over time. Consider the following.
Yes, all seven of these names beat the market last year. But if you go back to the last market peak a little over two years ago, only four out of the seven have beaten the market since. Amazon and Tesla are still trading below the levels where they ended 2021, and Alphabet has only recently caught up.
Zoom out even further and look at who the top ten stocks are in the S&P 500 over the last 40 years. There’s been some consistency with a few names lasting more than a decade, like IBM in the ’80s or GE in the ’90s. However, there’s also roughly 4.5 new companies that enter that top ten every five years.
As we often say at Ellevest, predicting the markets is impossible, and that extends to predicting which companies will be among the top ten in future years.
All this isn’t to say the Mag 7 won’t continue to deliver and dominate the S&P 500. They absolutely could. But some of those names could be replaced. We won’t know if or when. Which is why having a broadly diversified portfolio with exposures to many names is the key to keeping invested in the long term and avoiding FOMO. Trying to predict next year’s winners or chasing performance because you feel you missed out might feel good in the short term, but could be harmful to your portfolio in the long term. Keeping diversified means you’ll likely already own next year’s winners.
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