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Unveiling the Driving Force behind S&P 500's Performance: The Dominance of “The Magnificent Seven”

The S&P 500, a bellwether of the US stock market, has been experiencing an unprecedented trend in 2023, driven by the remarkable performance of a select few giants. This article delves into the market capitalization (market-cap) weighted data, revealing the influence of seven major stocks on the index's overall performance and its implications for investors.

Source: Factset, OIG Research

The chart exhibits a striking disparity in performance between two distinct groups of stocks within the S&P 500. On one side, we have 'The Magnificent Seven': Apple, Microsoft, NVIDIA, Amazon, Meta (formerly Facebook), Tesla, and Alphabet (Google's parent company). These industry behemoths have collectively surged, boasting an astonishing 63% year-to-date (to 16 Aug 2022) return.

On the other end of the spectrum lies the remaining 493 companies, which have underperformed considerably, delivering a modest 4.3% year-to-date return (to 16 Aug 2022). The index's structure, being market-cap weighted, accentuates the impact of the top-performing stocks, resulting in a disproportionately high contribution to the S&P 500's overall return from this elite group.

The remarkable outperformance of 'The Magnificent Seven' raises critical questions about the current market trends and the driving forces behind them. One prominent concern revolves around the emergence of a possible Artificial Intelligence (AI) bubble. All seven companies have deep ties to AI, either through providing essential AI hardware or integrating it into their products and supply chains. Speculations about the transformative potential of AI have fuelled tremendous enthusiasm, contributing to the surging stock prices of these tech giants.

Despite some sceptics dismissing the AI-fuelled rally as unsustainable, recent earnings reports from Google and Microsoft have exceeded expectations, reinforcing investors' confidence in these companies' valuations. If AI continues to drive genuine revolutionary advancements, the current gains might be justified, and these elite stocks may continue their impressive run.

An Index Divided

However, the concentration of market influence in just seven stocks poses a significant risk to the overall market. Should the AI bubble burst, the impact on the entire US equity market would be severe. This unbalanced scenario calls for a cautious approach, as the performance of the broader market reveals a contrasting story.

Source: Factset, SPDR SYP 500 ETF

Among the other 493 stocks, investors have displayed a clear aversion to cyclical sectors due to concerns about an impending economic downturn. Additionally, companies offering luxury goods have faced challenges as consumer confidence wavers. This division within the S&P 500 highlights the opposing themes: one driven by optimistic faith in groundbreaking technological advancements, and the other indicating a slightly more cautious outlook.

In conclusion, the dominance of 'The Magnificent Seven' has catapulted the S&P 500 to remarkable returns this year. While the AI-driven rally appears to be a strong driver, it also raises concerns about a possible bubble and its implications for the broader market. Investors must carefully navigate this landscape, considering both the impressive gains and the underlying market dynamics to make informed decisions.

As the year progresses, the market's true resilience will be put to the test, and only time will reveal whether this trend is a steppingstone towards a prosperous technological future or a bubble that demands caution and vigilance.

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