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Stocks: Big’s Beauty Fails Despite Magnificent Seven’s Success

  • The S&P 500’s largest companies have seen “unrelenting” outperformance over the past decade.
  • History shows that the biggest stocks typically fail to keep up their market-beating run.
  • GMO’s analysis reveals that nine out of the ten largest stocks in the S&P 500 underperformed on average in the year following their ranking.
  • The largest stocks become expensive, explaining their poor relative returns.
  • The top seven companies in the S&P 500 have swelled to 28% of the index, from 13% a decade earlier.
  • Big Tech stocks, known as the Magnificent Seven, outperformed the S&P 500 by an almost unimaginable 60% in 2023.
  • Mega caps have been practically unparalleled in their outperformance over the past decade.
  • The capitalization-weighted S&P 500 index has gained 4.8% this year, with only four stocks in the Magnificent Seven beating the index.

Introduction

The S&P 500’s largest companies have experienced continuous outperformance over the past decade. However, historical trends indicate that these mega-cap stocks often fail to maintain their market-beating run. According to GMO’s asset allocation team, nine out of the ten largest stocks in the S&P 500 have underperformed on average in the year following their ranking.

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Unseen Consequences of Big Stocks

GMO’s co-head of asset allocation, Ben Inker, and team member John Pease, argue that “big is generally anything but beautiful” when it comes to stocks. They highlight that the largest stocks become expensive, leading to poor relative returns. Data from 1957-2023 shows that the ten largest stocks in the S&P 500 underperformed an equal-weighted index of the remaining 490 stocks by 2.4% per year.

The Concentration Issue

The S&P 500 has become significantly more concentrated over the years. The top seven companies now account for 28% of the index, double the percentage a decade earlier. This concentration is primarily driven by the exceptional returns of Big Tech stocks, also known as the Magnificent Seven.

The Magnificent Seven’s Success

The Magnificent Seven, including Apple, Microsoft, Google, Amazon, Nvidia, Meta Platforms, and Tesla, have been closely watched by investors after their staggering performance in 2023. These companies outperformed the S&P 500 by a remarkable 60%. However, GMO’s analysis cautions that such exceptional outperformance is not sustainable in the long term.

Conclusion

While the S&P 500’s largest companies have enjoyed a decade of outperformance, historical data warns against assuming this trend will continue. The concentration of mega-cap stocks and their expensive valuations raise concerns about their ability to maintain their market-beating run. Investors should be cautious of blindly allocating their portfolios to the largest stocks, as history has shown that big is not always beautiful in the stock market.

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