There are nearly 60,000 listed companies around the world, but only seven that really matter right now.
The mega-cap U.S. tech stocks have assumed planet-like proportions around which all other global equities orbit.
Known as the magnificent seven – Apple Inc. AAPL-Q, Microsoft Corp. MSFT-Q, Alphabet Inc. GOOGL-Q, Amazon.com Inc. AMZN-Q, Nvidia Corp. NVDA-Q, Meta Platforms Inc. META-Q, and Tesla Inc. TSLA-Q – this group has grown in market capitalization by US$4.7-trillion this year alone.
That number is larger than the value of all but three of the national stock markets outside the United States.
All of the companies listed on the Toronto Stock Exchange, for example, had a total market cap of US$2.7-trillion in the U.S. market.
Chances are, your own financial well-being has some level of vulnerability to the magnificent seven stocks. Their share of the S&P 500 index has risen to nearly 30 per cent – a record level of concentration in U.S. stocks.
This raises some questions for everyday investors. Should they change how they invest in U.S. stocks? Is it a problem that the world’s largest and most diversified market is this top heavy? Yes and no.
This year is a rather extreme example of narrow leadership in stock markets. On the surface, the S&P 500 is having a solid rebound year after a sound trouncing in 2022. But the index’s year-to-date advance of 19 per cent owes a lot to the magnificent seven. Remove those seven stocks and the gain on the year shrinks to 6 per cent.
The effect is even more dramatic on a global scale. Through the end of October, the MSCI All-Country World Index, which covers 85 per cent of the investible equity universe, marked about US$3.5-trillion in gains, almost all of which were attributable to the magnificent seven.
It’s generally considered a good thing to have a larger number of companies contributing to index gains. Conventional market wisdom holds that market rallies with narrow leadership are fragile creatures, prone to vanishing at the slightest provocation.
There is something to that. Just last year, the Big Tech trade turned violently in the wrong direction, taking the entire market down in the process. The group lost an average of 46 per cent, making the index losses far worse than they would have been in their absence.
But when you zoom out and look at how stock markets behave over decades, this year isn’t such an outlier.
The famous research by Arizona State University finance professor Hendrik Bessembinder shows that the vast majority of stocks are duds, while a precious few are responsible for generating the market gains that investors rely on.
Between 1990 and 2020, stock markets globally generated roughly US$75-trillion in wealth. Half of that wealth was created by the best-performing 0.25 per cent of firms, or one in 400. And the top 2.4 per cent of stocks accounted for all net global wealth creation.
Going back to 1926, Prof. Bessembinder found that just 86 firms powered half of all wealth creation in the U.S. stock market.
The stock market is a proven performer over the long term. But it delivers those returns in a highly concentrated form.
Where it becomes a problem at the individual investor level, however, is when that concentration translates to excessive portfolio risk.
The U.S. stock market has never been
more concentrated than it is today
Seven largest companies as share of S&P 500 total market cap
30%
29%
28
26
24
22
20
18
16
14
12
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
The magnificent seven stocks have driven
the market higher in 2023
Indexed return
180
+71%
170
160
META,AMZN, AAPL,
MSFT, GOOGL,
TSLA, NVDA
150
140
130
S&P 500
+19%
120
110
+6%
100
Remaining 493 companies
90
Dec.
2022
Feb.
2023
April
June
Aug.
Oct.
Dec.
the globe and mail, source: goldman sachs
The U.S. stock market has never been
more concentrated than it is today
Seven largest companies as share of S&P 500 total market cap
30%
29%
28
26
24
22
20
18
16
14
12
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
The magnificent seven stocks have driven
the market higher in 2023
Indexed return
180
+71%
170
160
META,AMZN, AAPL,
MSFT, GOOGL,
TSLA, NVDA
150
140
130
S&P 500
+19%
120
110
+6%
100
Remaining 493 companies
90
Dec.
2022
Feb.
2023
April
June
Aug.
Oct.
Dec.
the globe and mail, source: goldman sachs
The U.S. stock market has never been more concentrated than it is today
Seven largest companies as share of S&P 500 total market cap
30%
29%
28
26
24
22
20
18
16
14
12
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
The magnificent seven stocks have driven the market higher in 2023
Indexed return
180
+71%
170
160
META,AMZN, AAPL,
MSFT, GOOGL,
TSLA, NVDA
150
140
130
S&P 500
+19%
120
110
+6%
100
Remaining 493 companies
90
Dec.
2022
Feb.
2023
April
June
Aug.
Oct.
Dec.
the globe and mail, source: goldman sachs
Canadian investors have been warned for years on the dangers of holding a disproportionate part of their investing portfolio in domestic securities. On this matter, Nortel Networks Corp. serves as a perennial cautionary example.
Nortel was once such a singular force in Canadian finance, it made the magnificent seven’s share of the U.S. market today look like small potatoes. At its peak, Nortel accounted for more than one-third of the benchmark Canadian index.
In 1999, the TSE 300 Composite Index – the predecessor to the S&P/TSX Composite Index – gained almost 30 per cent. Take away Nortel and BCE, which then owned a 35-per-cent stake in Nortel, and the index returns would have shrunk to just 6.5 per cent.
Any investor with a portfolio that resembled the Canadian stock market would have been heavily exposed to the fall of Nortel, which began in mid-2000. From a peak of $124.50, Nortel’s share price crashed to 67 cents within two years.
Now, nobody would compare the magnificent seven to Nortel, which has become a case study in financial mismanagement. For the most part, today’s tech giants are globally dominant growth machines.
But there are lots of investors that have treated the U.S. market as a one-stop shop – a global, diversified stock portfolio in a single index. The sizzling rise of the magnificent seven stocks raises new doubts about that approach.
“While the performance of these stocks has been spectacular, it has led to the increased concentration of market-like portfolios, reducing the benefits of diversification and increasing a portfolio’s exposure to idiosyncratic risks,” Larry Swedroe, a financial author and director of research for Buckingham Strategic Wealth, wrote last week.
“Done properly,” Mr. Swedroe added, “diversification of risk is an investor’s friend.”