The largest companies in the S&P 500 have enjoyed a decade of exceptional performance. However, history has shown that these market leaders often struggle to maintain their edge, as reported by Jeremy Grantham’s GMO asset allocation team.
In their first-quarter letter to clients, Ben Inker, GMO’s co-head of asset allocation, and John Pease, a team member, highlight that “big is generally anything but beautiful” when it comes to investing. Examining data from 1957 to 2023, they discovered that nine out of the top 10 stocks in the S&P 500 typically underperformed in the year following their ranking.
The reason behind this underperformance, according to Inker and Pease, is that the largest stocks become inflated in value. This emphasis on anti-value has historically led to substantial costs and ultimately resulted in poor returns for these companies. In fact, since 1957, the top 10 stocks in the S&P 500 have consistently underperformed an equally weighted index of the remaining 490 stocks by an average of 2.4% annually.
GMO reports that the concentration of the S&P 500 has significantly increased over time. Founded in 1977 by Grantham, a renowned investor who has consistently warned about market bubbles, the firm reveals that the top seven companies now account for 28% of the index compared to only 13% a decade ago. These companies have outperformed the average stock in the U.S. equities market by a significant margin.
Investors closely monitor the “Magnificent Seven” or Big Tech stocks—Apple Inc., Microsoft Corp., Google parent Alphabet Inc., Amazon.com Inc., Nvidia Corp., Facebook parent Meta Platforms Inc., and Tesla Inc.—within the S&P 500. These megacap companies experienced unprecedented growth in2023.
While steering portfolios away from the largest stocks proved disastrous over the past decade, especially in the previous year, the GMO letter asserts that historically, this approach has been highly lucrative.
The Magnificent Seven Outperform the S&P 500 in 2023
According to a recent letter, the Magnificent Seven defied the odds in 2023 by outperforming the S&P 500 index by an astounding 60%. This impressive feat marks a break in the consistent downward trend of cap-weighted underperformance. The S&P 500 index itself experienced a notable climb of 24.2% in 2023, largely propelled by the gains made by Big Tech companies.
S&P 500 Touches 5,000: A Milestone for the Market
In a historic moment, the stock-market benchmark briefly surpassed the 5,000 mark for the first time ever, before experiencing a slight pullback. It ultimately closed at its ninth record high of 2024 so far. This milestone achievement presents new opportunities and potential implications for the market.
The Mega Caps’ Unparalleled Outperformance
Over the past decade, the performance of the Magnificent Seven has been virtually unparalleled among mega caps. With the exception of 2022, they consistently outperformed the market. This exceptional performance can be attributed to both the unusually low valuations of mega caps at the beginning of the decade and their remarkable earnings growth at a rapid pace. Microsoft and Amazon achieved this by reinventing themselves, whereas Apple, Alphabet, Meta, Nvidia, and Tesla dominated their respective industries.
A Historical Perspective on Mega Caps
Despite the recent success of the largest 10 companies, historical data covering the period from 1957 to 2023 shows that, on average, they have significantly trailed behind the average S&P 500 stock. This highlights the unique nature of the Magnificent Seven’s outperformance.
Current Performance and Growing Concentration
In 2024, through Thursday, the capitalization-weighted S&P 500 index has gained 4.8%, according to FactSet data. Among the Magnificent Seven, only Nvidia, Meta, Amazon, and Microsoft are currently outperforming the S&P 500.
The Decline of Diversification
Over the past decade, the S&P 500 index has become less diversified. In comparison to ten years ago, it is now more than twice as concentrated. This unprecedented decline in diversification has significant implications for market dynamics and investment strategies.
S&P 500 Nears 5,000: Potential for Uncertainty
As the S&P 500 approaches the milestone of 5,000, concerns about potential market volatility and uncertainty arise. Examining historical trends can provide valuable insight into the possible outcomes.