Discovering Investments Outside the Magnificent Seven

Mitch discusses how investors should prepare their portfolios for the high levels of dispersion (lack of coordinated movement) and concentration in today's market.

Are Dispersion and Concentration in the Stock Market Too High? U.S. large cap stocks, as measured by the S&P 500, delivered a solid performance in the first half of 2024. In January, the index eclipsed an all-time high, and in the five months that followed, it reached 31 more. Volatility has also been relatively subdued. In the first six months, there was only one instance when the index rose or fell by more than 2% (it went up).1 But it hasn’t been a story of a rising tide smoothly lifting all boats. In fact, looking under the hood at individual stock returns reveals quite the opposite. As I write, approximately 40% of stocks in the S&P 500 are at least 10% below their all-time highs, with dozens of stocks still in negative territory for the year. Is the S&P 500 Too Concentrated? In this week’s Mitch on the Markets, I am pleased to offer our new July Stock Market Outlook Report 2, which delves into the heavy concentration of technology companies in the S&P 500 and its implications for investors. The report covers key U.S. economic data, highlighting modest GDP growth, rising incomes and spending, cooling inflation, and a mixed labor market. You’ll also find: Global market data Zacks S&P 500 earnings insights Zacks sector picks And more… If you have $500,000 or more to invest, request our free July Stock Market Outlook Report 2 today! Many readers likely have a general understanding of how this is happening—a handful of mega-cap technology companies are making an outsized impact, and the effect is bolstering overall returns. Indeed, in the first half of 2024, just four of the “Magnificent Seven” stocks contributed over half of the S&P 500’s total return. The picture we’re left with is one with historic levels of dispersion and concentration in the S&P 500. And that has some investors worried that year-to-date gains are unhealthy, unbalanced, and susceptible to a quick reversal. High Dispersion The term ‘dispersion’ in equity markets refers to a lack of correlated movement among stocks, which is what we’ve seen at near historic levels within the S&P 500 this year. Dispersion rose in the aftermath of the pandemic, as technology stocks soared while many other categories of stocks—particularly value names—lagged. Dispersion fell in 2022 with rising interest rates and the bear market, but it has risen again recently driven by the Magnificent Seven and surging earnings growth tied to Artificial Intelligence. As seen in the chart below, the rise of the Magnificent 7 has not been pure speculation—earnings growth has been powerful over the past several quarters and should continue apace in 2024. The Magnificent 7-Quarterly Earnings and Revenue Growth Rate (YoY) Source: Zacks Investment Research Many narratives about high dispersion make it seem as though the remaining 493 S&P 500 stocks are in the doldrums, but that’s not quite right. About 60% of the stocks in the index are 10% higher than their low points in 2024, and the other half of the S&P 500's year-to-date gains have been driven by the broad swath of non-Magnificent Seven companies in the index that have posted solid performance for the year. But earnings are the main reason I do not get overly worried about high year-to-date dispersion in the S&P 500. According to Zacks Investment Research, S&P 500 earnings excluding Technology are poised to grow 6% for the full year 2024, and it appears possible that the ‘remaining 493 stocks’ in the index could deliver stronger earnings growth than the Magnificent Seven by the fourth quarter—thereby closing the earnings gap and bolstering the case to own a broad set of equities outside this narrow group, in my view. High Concentration Over the past 50+ years, the composition of the S&P 500 has changed substantially. In the 1970s, for instance, Industrials and Materials had significant weightings, making up over 25% of the index. Today, those two sectors combined are only about 10.6% of the index. Fast forward to the present day, and Information Technology companies make up 32.4% of the S&P 500 (as of June 30), with the share rising to 41.7% when including Communications Services. Financials have also become bigger, now comprising 12.4% of the index. In the 1970s, Technology and Financials combined to make up about 13% of the S&P 500. Today, they make up more than half of the index. Technology’s high concentration has also impacted dividends. Technology companies are generally growth stocks, and growth stocks tend to hoard cash or invest in future growth—versus returning cash to shareholders in the form of dividends. Given this insight, the S&P 500's dividend yield has done what investors might expect—it's gone from over 4% in the 1970s to an average of 1.45% in the 2020s. Bottom Line for Investors So, what does this all mean for investors? From a high dispersion standpoint, I think it strengthens the case for owning a broadly diversified portfolio of equities, which could even mean exposure to small-caps, mid-caps, and perhaps some foreign stocks depending on your goals and risk tolerance. In a diversified portfolio, you will almost always see variance—some strong performers, and some weak ones. The outliers tend to neutralize each other’s impact on portfolio returns over long stretches of time, leaving the middle-of-the-road stocks doing the heavy lifting. From a high concentration standpoint, if you're passively holding the S&P 500 index, perhaps it’s good information to know how heavily you’re allocated into Technology and Finance. Dividends are also worth considering. If the S&P 500’s yield is lower than an investor wants both from an income and a volatility perspective, it might make sense to seek out a more customized strategy that emphasizes owning companies with solid dividend yields. To help you stay informed and strategically prepare your portfolio, I am excited to offer our comprehensive July Stock Market Outlook Report 3. This report is packed with detailed forecasts and expert insights, including: Capital markets commentary: is the S&P 500 too concentrated? Key U.S. economic data Global market data Zacks S&P 500 earnings insights Zacks sector picks And more… If you have $500,000 or more to invest, request our free Stock Market Outlook Special Report 4 today! About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. At Zacks Investment Management, we work with clients with $500,000 or more to invest, and we use this independent research, 35+ years of investment management experience, and tools we’ve developed to design customized investment portfolios based on each client’s individual needs. The end result is investment management that is research driven, results oriented and client focused. Talk to a Zacks Wealth Advisor today. © Zacks Investment Management  |  Privacy Policy 1 Wall Street Journal. June 28, 2024. 2 Zacks Investment Management reserves the right to amend the terms or rescind the free-Stock Market Outlook Report offer at any time and for any reason at its discretion. 3 Zacks Investment Management reserves the right to amend the terms or rescind the free-Stock Market Outlook Report offer at any time and for any reason at its discretion. DISCLOSURE Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. 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