Can S&P 500 Still Win If Mag 7 Does Not Perform?

Given that there have been tremendous risk in the market capitalization indices (especially S&P 500) with the concentration in the largest stocks. The Top 7 stocks took up almost 30% of S&P 500 based on weightage,

I feel that it is important for us to look at how their performance year-to-date (YTD) have been, I am a science person, so using Isaac Newton’s wisdom “What goes up, must come down”.

Nvidia have the greatest YTD with more than 20%. Many investors are very happy with YTD returns in 2023 but are highly skeptical that they can hold, which we start to see some disparity between these 7 members. Tesla have a negative YTD return at -15.97%.

If the Magnificent 7 (which took up almost 1/3 of the S&P 500) can provide YTD returns of 20%+, while the average stock basically endured a technical recession, then why we do not see the remaining 493 stocks help the market cap weighted index, for example, Mag 7 performance dips in the beginning of 2024?

Question we need to ask ourselves is the recent S&P 500 new highs, are they brought up by Magnificent 7? Or we are seeing the remaining 493 stocks contributing?

In this article I will try to examine and see if this is the case.

Using the S&P 500 equal weight index (ticker: RSP) as a proxy for the average stock, this has been the worst relative performance year to the cap weighted index since 1998. It should be noted that the equal weight index underperformed handily again after this in 1999 but then went on to outperform the cap weighted index for almost the entirety of the 2000s.

Earnings stability and growth from these mega-cap companies have helped to produce performance discrepancy. Something we need to be aware is the soaring valuation multiples in the largest names, these valuation have driven market’s return in 2023, but will it be the case in 2024?

In 2023, we have seen that negative 2023 year-over-year earnings for all stocks outside of the Magnificent 7 reflect the dull economic picture that so many predicted this time last year. Magnificent 7 was the ones who has help to carry forward the brunt of the earnings load, helped by strong demand, cost-cutting measures, and not forgetting the popularity of artificial intelligence (“AI”).

The heavy concentration of larger weights in growth stocks adds benchmark risk. Passive investors enjoyed the Mag 7 rally but are also exposed to a potential turn in sentiment because of a lack of diversification in the index and the increasingly correlated trading patterns of these names. A comprehensive evaluation of each stock’s business potential and valuation should be done and adjusted accordingly to a portfolio’s investing philosophy at appropriate weights, even though mega-caps include attractive companies.

Investors in mid-cap stocks, the 800 smaller companies in the Russell 1000, must be aware of the unusually high concentration of value stocks relative to history. Value stocks require a different type of analysis than growth stocks for investors to identify the best long-term opportunities.

If the Mag 7 were to experience some negative volatility, could the “remaining 493” potentially hold the market and does not really cause any sell off. If we look at the recent week, we could actually see that the breadth of market leadership have expand and S&P 500 did rally to new highs without Mag 7 leading the way.

If the Mag 7 stocks flatline over the next 12 months, and if the multiples on forward earnings for the rest of the market flatlines, at about 15x on average, forecasted EPS growth will be the return of the market. If this were to occur, the average stock would remain below its post-COVID highs. Only 24% of stocks in the S&P 500 trade within 10% of their all-time highs (vs. 28% historical average), much lower vs. prior bull market peaks. Stated another way, bull markets tend to end with much better participation.

This would mean that the average stock has a runway of future returns that could actually hold up or help S&P 500, without the help from the mega caps, (e.g. Mag 7).

While we might think this is possible, something that the Mag 7 bring about performance growth is earning growth, we might look at these Mag 7 upcoming earnings growth.

Based on what we have seen so far, it looks like there is still possibility of S&P 500 continue to win, despite performance from Mag 7 not up to par. There are value stocks in the remaining 493 stocks, which we might want to spend some time to look at the company and valuation.

Appreciate if you could share your thoughts in the comment section whether you think S&P 500 can still win despite Mag 7 not performing.

Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.