While the ‘Magnificent 7’ accounted for the majority of the S&P 500 gains in 2023, this narrow performance concentration is finally showing signs of broadening out. Since 10-year U.S. Treasury yields peaked in late October, the equal-weighted S&P 500 has outperformed the Magnificent 7, suggesting investors may no longer need to depend on the strength of these seven giants, and can instead begin to consider the cyclicality of small-cap stocks.

Magnificent 7 performance vs. S&P 500 equal-weighted and market-cap-weighted
Calendar year 2023, rebased to 100 at January 1 and again at October 19

Calendar year 2023 magnificent 7 performance vs. S&P 500 equal-weighted and market-cap-weighted index
Note: Magnificent 7 comprised of Alphabet, Apple, Amazon, Meta, Microsoft, Nvidia, Tesla.
Source: Standard & Poor’s, Bloomberg, Principal Asset Management. Data as of December 31, 2023.

The so-called “Magnificent 7” accounted for most of the S&P 500 gains in 2023, recording an outstanding total return of 107% last year. While the market-cap-weighted S&P 500 delivered a 26% total return, the equal-weighted S&P 500 was up only 14% in 2023—the largest one-year underperformance since the dot com bubble.

Although the narrowness of the rally is a potential concern, U.S. equity market breadth is already showing signs of broadening out:

  • In 4Q23, the market-cap-weighted index delivered similar returns to the equal-weighted index.
  • Since 10-year U.S. Treasury yields peaked at almost 5% in late October, the equal-weighted S&P 500 has outperformed the Magnificent 7.
  • The equal-weighted S&P 500’s outperformance of the market-cap index has remained despite yields troughing in late December.

With the market less concerned about recession, investors may no longer need to seek out the balance sheet strength of the Magnificent 7 and can instead begin to consider the cyclicality of small-cap stocks. History suggests that small-caps typically outperform once the U.S. economy enters a new stage of recovery and the Fed starts a rate-cutting cycle.

Entering 2024, the valuation gap between large- and small-cap stocks remains considerable. This suggests that while risks may be attached to the market’s dependence on the Magnificent 7, there is also significant unrealized opportunity in the small-cap space.

Disclosure

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