AI dominance drove the S&P 500’s record highs in 2024. Will new sectors, led by the MAGA-7, reshape market dynamics? Here's what investors need to know.
Can’t fight this feeling any longer. It has been a solid year for the US economy and the equity markets. Someone who is astute might point out that some of the biggest legs up this year have been made with narrow breadth. That is a fancy way of saying that the biggest moves up were made by the few capitalization-heavy stocks that dominate the cap-weighted indexes like the S&P500. You know the usual suspects of which I speak. A good way to understand this is to compare the S&P500, a cap-weighted index, to its equal-weighted half-sibling. The former is up by 26.87% and latter, only by 15.44%. Don’t get me wrong, 15% return is quite respectable, but when it comes to returns—well, more wins.
Understanding that the S&P500 is capitalization-weighted is critical to understanding the nuanced difference. The companies with biggest market caps have the biggest impact on the index’s performance. To get a big market cap, a company needs one key element and that is outstanding stock performance. I like to refer to S&P500 as an elite club—the biggest companies in the world. In that club, only the 10 biggest are allowed in the penthouse, and it is those 10 that make all the decisions. If they do well, so does the elite club. So, in essence, it is the most elite members of the most elite club that determine how the club looks on the outside.
You know who those 10 elites are. They are, in order of big to small: Apple, NVIDIA, Microsoft, Amazon, Meta, Tesla, Alphabet A, Alphabet C, Broadcom, Berkshire Hathaway, and JPMorgan Chase. Now, I know that’s 11, but Alphabet takes up two slots with its 2 separate share classes. All but 2 of those top 10 have something to do with AI and indeed the top 7 of the group are members of the Magnificent 7.
Let’s just say it, the opportunity for AI is huge and we are just at its early stages. It is, therefore, understandable that the Mag-7, and the cap-weighted S&P 500 did so well this year. It is, indeed, justified! Let’s look at it another way. If you had invested in the Mag-7 only, you would have racked in a cool 52.5% year to date. So, it is fair to say that the Mag-7 is the elite of the elite… of the elite.
Now going back to the equal-weighted index—by no means, a loser with 15% gains, how could it be so far off from the S&P500 and its elite Mag-7? Well somewhere right near the bottom of the list is FMC Corp, an agricultural chemicals company. Its year-to-date performance is down by -13.5%. In the traditional index, FMC is weighted by 0.01% versus top-dog Apple’s 7.25%, so it doesn't take away much from the S&P500’s return. In the equal-rated index both Apple and FMC get the same treatment, so its FMC’s losing YTD return pulls the whole index down. That is how you end up with a significantly underperforming equal-weighted index.
So, does all this even matter? Doesn’t it look like the Mag-7 will just keep dominating forever. Well, we know that is not likely, because forever is a mighty long time. While AI is big and those companies seem to be doing everything right at the moment, there are always opportunities for companies on the lower floors of the elite club to move up. Where do those opportunities come from? Well, pure company performance and market recognition is an obvious one.
How about the inauguration of a new President that has the backing of both Congressional chambers in his party and an agenda that is somewhat of a departure from the current market regime? This new one may not hold back the Mag-7, but it may provide opportunities for other sectors through deregulation and incentives. What then, would a MAGA-7 look like? Well, you may as well pick the brightest and best from Industrials, Materials, Financials, Defense, and Consumer Discretionary sectors. Those top 7 will likely do better in the next several years compared to the last several years. That will certainly afford those 7 opportunities to move up floors in the club.
Will they get to the top floor? Well, you have to decide that. Can a Defense company get the type of multiples enjoyed by the Mag-7? Is the available market for Defense growing as fast as AI? I know your answers already, but don’t be fooled. While those MAGA-7 stocks may not ever make it to the top floor, they will certainly climb fast, and by doing so, change the contours of the S&P500—most likely closing the gap between the cap-weighted and equal-weighted indexes, thus… wait for it… broadening the breadth of future market moves. Keep your Mag-7, but don't forget the MAGA-7.
YESTERDAY’S MARKETS
Stocks traded off yesterday as exhausted buyers keep looking for a way to close the books for 2024, in great need of rest, and perhaps just one more good piece of news to bring it home with a bang—they will have to wait until Chairman Powell speaks next week. The Producer Price Index / PPI came in a bit hotter than expected yesterday—as it is considered to be a leading indicator of consumer inflation, investors, rightly, were spooked by the release and its power of premonition.
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