Do Dominant Megacap Companies Spell Doom For Stocks?

While the market has seemingly begun to expand beyond a handful of the largest stocks, the so-called Magnificent 7 have continued to outperform so far this year after massive returns in 2023. The Magnificent 7 is made up of Microsoft.
MSFT
(MSFT), metaplatforms
full board
(META), Amazon.com (AMZN), Apple
AAPL
(AAPL), NVIDIA
NVDA

THERE
(NVDA), Alphabet (GOOGL) and Tesla
TSLA
(TSLA). Does this mean the stock market will fall sharply when those leaders inevitably falter?

In 2023, mega-cap stocks outperformed the average S&P 500 company by the widest margin since the start of the tech bubble in the late 1990s.

Additionally, the ten largest companies now account for nearly 34% of the total market capitalization of the S&P 500. While this may cause concern, market concentration was greater than current levels in the past and, by some measures, was greatest from 1926 to the 1960s.

Even though the Magnificent 7 is a relatively new creation, it is similar to the top ten stocks, as every company except Tesla (TSLA) is also in the top ten.

Looking at the calendar years with positive returns in which the top ten stocks contributed the most to the S&P 500's returns, 2023 ranks as the second highest since 1991. While there are notable years (2007 and 2021) in which the S&P 500 had considerable losses in the following Overall, the S&P was even higher 60% of the time, with an average return of 6.6%.

Momentum strategies buy stocks that have been the best performers over a prior period, usually 12 months, and hold them, waiting for the outperformance to continue. These strategies are then rebalanced at a constant cadence to buy the next batch of best-performing stocks. As you can imagine, momentum strategies have performed quite well in 2024, as many of the same stocks, such as the Magnificent 7, have continued to outperform. Again, there is no certainty that these stocks had to perform poorly in the following year, as momentum stocks had positive returns 60% of the time, with an average return of 7.4%.

As noted above, in 2023, the S&P 500 outperformed the average stock, as measured by the equally weighted S&P 500, by the second-largest margin since 1991. Once again, the evidence indicates that there will not be an inevitable decline in the S&P 500 in the next year. . Historically, the S&P 500 and momentum strategies have been higher 80% of the time over the following year, with average returns of 24.7% and 21.9%, respectively.

It should be noted that both the tech bubble and the global financial crisis had positive returns for several years before the eventual day of reckoning. The current enthusiasm for technology and artificial intelligence (AI) is not analogous to the tech bubble because the current crop of big tech companies is incredibly profitable. The price paid for these companies will affect expected future returns, but a broad-based decline seems unlikely at this time.

The next crucial economic data for the markets is Friday's monthly employment report. Weekly jobless claims do not indicate that the labor market is weakening enough to lead to a recession. Still, the payrolls report will be closely watched for its implications for the economy, wage pressures and inflation.

Federal Reserve Chair Powell's rate-cutting comments after the Fed meeting raised market odds to an 85% chance that the Fed will ease monetary policy in June, up from 60%. The last week. Federal Reserve Governor Waller poured some cold water on the euphoria on Wednesday, and the odds of a June cut are currently around 66%. The odds strongly favor the Federal Reserve beginning short-term interest rate cuts in June or July. Fed funds futures expect three cuts of 25 basis points (0.25%) each in 2024.

While the history of performance after a concentrated market is not an argument for caution, overly positive investor sentiment might be a better reason to do so. Indeed, stocks may continue to rise, but investor optimism has reached a level that typically leads to at least a pause at some point.

Despite some understandable fears, historically the strong performance of stocks based primarily on a small number of large companies has not always led to a bad outcome. In fact, one could argue that we are witnessing a performance expansion this year. More concern should be given to elevated expectations of a soft landing for the economy and strong earnings growth built into stock valuations. While these optimistic results seem likely to come to pass, stocks have less room for error after the S&P 500's 25% rally since late October. Stock market timing is silly, but it makes sense here to make sure your portfolio matches your risk tolerance and some caution on the margins. Next week will be quiet on the earnings front, but the first quarter of earnings season begins the following week. Friday's monthly jobs report will be closely watched as it adds another piece of the puzzle to the prospects for Fed rate cuts.