Insights

A Historical Perspective: Looking at the Top-Heaviness of the Market

02.23.24

One of the most impactful trends that has carried through from 2023 into this year has been the continued outperformance of the largest technology companies in the world. By looking at the market from a historical perspective, we can explore why it may be occurring and why it still makes sense to diversify your portfolio.

The Magnificent 7

The group of tech stocks now affectionately known as the “Magnificent 7” has seen their share of prices soar since the beginning of 2023 and has carried the overall equity market to new all-time highs. Much of this performance has been driven by the emergence of artificial intelligence as a potential game changer for economic and corporate productivity. These seven stocks, as seen below, have been outperforming since the outset of the pandemic in early 2020.

Past performance is not indicative of future returns.  This should not be a recommendation to buy or sell any security. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested directly.

An equal-weighted basket of these stocks has outperformed the Nasdaq and the S&P 500 indexes by over 200% since January 2020, which begs the question: where would the market be today without these companies?

It is important to note that these companies have also been outperforming from a fundamental standpoint as well. Looking at almost any metric, these companies have been growing faster and more profitably than the rest of the market.

Looking at 2023 alone, the Magnificent 7 grew profits at five times the rate of the broader S&P 500 and taking these companies out of the index would have resulted in a mere 2% net income growth in 2023.

S&P 500 2023 Net Income Growth

Source: Strategas Research, 2/12/24

Past performance is not indicative of future returns.  This should not be a recommendation to buy or sell any security. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested directly.

The outlook for 2024 is more of the same with the gap in profit growth closing a bit, but with markets still expecting the Magnificent 7 to grow profits at over three times the rate of the other 493 stocks in the S&P 500.

S&P 500 2024 Estimated Net Income Growth

Source: Strategas Research, 2/12/2024

Past performance is not indicative of future returns.  This should not be a recommendation to buy or sell any security. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested directly.

Current Market Conditions versus the 1999 Tech Bubble

Some have likened the current market conditions to the tech bubble in the late 1990s when investors became exuberant over the transformative potential of the internet and drove up the shares of early-stage internet companies to unsustainable levels. The primary argument against that comparison to today’s AI-driven enthusiasm is that the companies at the top today are mature, profitable, and not quite as expensive. While we agree that the speculation today is not nearly as extreme, the lessons from that period are still worth considering. With hindsight, the internet proved to be the most transformative innovation in modern history, and yet the tech-heavy Russell 1000 Growth index performed terribly for several years following the tech bubble run-up, while other areas of the market that were not caught up in the enthusiasm fared better.

 12/31/19991/31/2024
IndexP/E RatioNext 5-Year ReturnP/E RatioNext 5-Year Return
RUSSELL 1000 GROWTH46x-7.50%34x?
S&P 50030x-1.18%23x?
MSCI EAFE28x-1.14%15x?
S&P SMALL CAP 60025x13.41%16x?
S&P MIDCAP 40023x10.84%18x?
RUSSELL 1000 VALUE20x5.39%17x?

*P/E ratios based on trailing EPS; Returns are annualized
  Source: Bloomberg, Black Diamond

Past performance is not indicative of future returns.  This should not be a recommendation to buy or sell any security. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested directly.

As you can see above, we have listed the starting price-to-earnings (P/E) ratio of various market indexes at the end of 1999 with their subsequent returns from 2000-2005. We have also added the P/E ratios as of the end of January 2024, which show a similar pattern to 1999, although a little less extreme. Clearly, starting valuations played a big role in the returns following the tech bubble, and investors who concentrated in the internal darlings paid the price. Fast forward to today, AI could very well be the productivity boost that our economy needs for the next decade and beyond, but that is not guarantee that the stock associated with it will produce positive returns from today’s valuations.

Maintaining a Broadly Diversified Portfolio

While being well-diversified, by definition, never produces the absolute best returns, it does promote discipline during periods like today when it’s easy to get caught up in enthusiasm and give up on areas of the market that seem out of style.  This is why we maintain exposure to equities across sectors, market caps, and geographies, seeking to generate the long-term returns available in equity markets without getting too exposed to any one trend.  We believe this approach is consistent with our focus on achieving our clients’ long-term goals through prudent asset allocation, thoughtful security selection, and a great deal of patience.


Please send your questions, comments, and feedback to: info@mai.capital. Any statement non-factual in nature constitutes only the current opinion of this author which is subject to change without notice. Certain statements are of future expectations and other forward-looking statements are based on management’s current views and assumptions. Any statistics mentioned have been obtained from sources we believe to be reliable, but the accuracy and completeness of the information cannot be guaranteed. Neither the information nor any views expressed should be considered investment, legal or tax advice, or constitute as a recommendation to buy or sell any security, strategy, or product. It should not be assumed that this is a forecast of future events or that any security transactions, holding, or sector discussed where or will be profitable or that the investment recommendations or decisions we make in the future will be profitable. Past performance is not indicative of future results.

We look forward to learning about your financial goals.

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