Smaller stocks’ performance compared with the Magnificent Seven

In recent financial market trends, the performance of smaller stocks has shown notable improvement compared to the high-flying "Magnificent Seven." This article delves into the dynamics between these two segments, providing an in-depth financial analysis based on recent data and historical context.

Performance of Smaller Stocks

The Russell 2000 Index, which tracks 2,000 smaller public American firms with a median market capitalization of $900 million, recently gained 3.6% in one trading day. This marks the best relative performance for smaller stocks in several years.

On the same day, the Russell 2000 outperformed the tech-heavy Nasdaq 100, which declined by 2.2%. The spread between these indexes' daily performances was among the largest in the last decade. This trend continued into the following day, with the Russell 2000 gaining 1.8%, while the Russell 1000 rose by 0.7%, and the Magnificent Seven stocks increased by an average of 1.1%.

Historical Context

Historically, periods where smaller stocks outperform larger ones have often been followed by broader market gains. For instance, during the five most comparable instances when the smaller S&P stocks outperformed the top 10 stocks in a day, the S&P rallied a further 4.5% over the next month. Meanwhile, the top 10 stocks fell by an average of 4.8% over the same period.

This "catch-up" phenomenon suggests that after periods of high concentration and wide valuation dispersion, smaller, less expensive stocks tend to outperform. Although this rebalancing can take years to materialize, it indicates a potential shift in market dynamics.

Market Concentration and the Magnificent Seven

The Magnificent Seven—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla—have dominated the US equity market, significantly contributing to the S&P 500’s recent all-time highs. Their combined market capitalization equals the total valuations of the index’s 427 smallest constituent stocks.

Concentration in these seven stocks has raised concerns. Nearly 90% of the price returns delivered by the S&P 500 over 2023 were attributed to these seven stocks. In contrast, the median stock in the index returned a modest 8.2% during the same period.

Earnings Projections

The Magnificent Seven are forecasted to achieve a combined annual earnings growth of 27.8% during the second-quarter earnings season. This is significantly higher than the 5.2% profit expansion projected for the other 493 companies in the S&P 500.

Financial Implications

Given current market dynamics, investors might find it prudent to rebalance their portfolios. Diversifying investments could help mitigate risks and capture broader market gains, ensuring that returns are not overly dependent on a handful of high-performing stocks.

For medium-term portfolio building, focusing on opportunities in the broader market rather than solely on the Magnificent Seven could be advantageous. This strategy leverages historical tendencies for smaller stocks to outperform after periods of high concentration.

Relevant News Analysis

Recent news articles have highlighted these trends and provided additional context:

  • Vanguard (July 9, 2024) discussed market cyclicality and how large-caps versus small-caps have performed historically.
  • Forbes (July 12, 2024) noted that small-cap outperformance continued with the Russell 2000 gaining 1.8% while larger indices saw more modest rises.
  • CNBC (July 1, 2024) highlighted that the Magnificent Seven stocks accounted for more than half of the S&P 500’s gain in 2023.
  • J.P. Morgan Asset Management (July 2, 2024) emphasized that opportunities in US stocks extend beyond these seven giants.
  • Lord Abbett (December 14, 2023) argued that investors focused solely on these mega-cap leaders might miss attractive opportunities in faster-growing smaller companies.
  • Mellon (January 30, 2024) provided insights into how these seven stocks have consistently outperformed other S&P components over recent years.
  • Yahoo Finance (November 15, 2023) illustrated how these seven stocks have dominated market performance with higher net profit margins compared to other companies.
  • Investopedia (March 30, 2024) questioned whether the dominance of these seven stocks might be waning as only four outperformed the S&P 500 in early 2024.
  • Thornburg (May 17, 2024) suggested looking beyond these US giants to other global investment opportunities.
  • Fool Wealth (January 30, 2024) discussed reasons behind the high valuation of these seven stocks and how it affects overall market dynamics.
  • Bankrate highlighted that these seven stocks represent about 41% of the Nasdaq 100's performance.
  • Investopedia explained that small-cap stocks tend to outperform big-caps over time due to their rapid growth potential.

Conclusion

The recent outperformance of smaller stocks relative to the Magnificent Seven suggests a potential shift in market dynamics that could benefit diversified investment strategies. Historical trends and current financial data indicate that now may be an opportune time for investors to explore broader market opportunities beyond the dominant tech giants.