Turns out, the stock market can succeed without the Magnificent Seven

By Joseph Adinolfi

Skeptical investors worried the indexes had grown too dependent on a handful of stocks. Now, the market is moving on without its former darlings.

For much of the past two years, market watchers have worried about whether the stock-market rally could survive without the Magnificent Seven.

Now, after a sometimes-rocky third quarter, they finally have an answer: the S&P 500 index has recently charged to fresh record highs, and it didn't wait around for Big Tech to catch up.

"Over the last few months, a few myths have been busted," said Michael Arone, chief investment strategist for State Street Global Advisors, during an interview with MarketWatch on Wednesday. "One is that without a rally in the 'Mag Seven,' that ultimately market returns were doomed."

"In fact, over the past three months, the S&P 500 is up more than 4.5%," he said.

During that stretch, the Magnificent Seven- typically defined as Nvidia Corp. (NVDA), Apple Inc. (AAPL), Microsoft Corp. (MSFT), Alphabet Inc. (GOOG) (GOOGL), Tesla Inc. (TSLA), Meta Platforms Inc. (META) and Amazon.com Inc. (AMZN) - underperformed the broader index for the first time since the final quarter of 2022, according to analysts at Deutsche Bank.

Starting in mid-July, expectations that the Fed would aggressively cut interest rates has sparked a rotation in leadership away from Big Tech and toward erstwhile laggards, like utilities, real estate and financials.

Already, the Magnificent Seven's share of the S&P 500's total market capitalization has eased from a peak north of 34% in July, to below 32% in September, according to the latest data from LSEG.

Changing of the guard

The upshot is that nearly two years after the S&P 500 bottomed out in October 2022, more stocks are finally pitching in to help push the index higher, just as many bullish investors had hoped.

While previous episodes of broader participation had quickly fizzled, market strategists say there have been reasons to expect that the latest shift has staying power. This could even hold if the U.S. economy slows in the quarters ahead, as projected by the Federal Reserve.

"Honestly, it's been a healthy thing to see so many sectors doing well," said Bret Kenwell, an investment analyst at eToro, during an interview with MarketWatch.

If previous easing cycles are any guide, falling interest rates should disproportionately benefit sectors like financials and healthcare, Arone said.

But falling rates are hardly the only tailwind that should benefit a more diverse group of stocks. Expectations that more S&P 500 firms will report stronger earnings growth going forward could help to entice more companies to join the rally.

Beginning later this year, the other 493 companies in the S&P 500 outside the Magnificent Seven were expected to see a marked improvement in profit growth, according to FactSet data.

   Expected S&P 500 earnings growth    Q3 2024  Q4 2024  Q2 2025  Q3 2025 
   The Magnificent Seven                  17.9%    16.3%  15.2%    14.5%    16.6% 
   The other 493 companies                 1.7%    13.9%  14.2%    13.0%    15.6% 

Source: FactSet

Relatively attractive valuations should help to boost stocks outside of the elite grouping as well. At current prices, the Magnificent Seven were currently valued at more than 30 times expected earnings over the next 12 months, according to LSEG data.

By comparison, the other 493 companies in the S&P 500 were valued at just over 19 times expected earnings.

Many companies were still trailing the S&P 500 year-to-date, suggesting there could be plenty of room for them to play catch-up. As of the end of the third quarter, the number of companies in the S&P 500 that had outperformed the index stood at 34%, compared with 28% for the full calendar year of 2023.

The Magnificent Seven stocks had generated nearly 60% of the S&P 500Index's return year to date through June, according to a report from investment firm Boston Partners. In 2023, that figure was 62%.

Much has changed since the early days of the rally. High interest rates, used by the Fed to combat the worst wave of inflation in 40 years, had helped tamp down profits for many companies. As a result, investors sought out the handful of firms with fortresslike balance sheets that managed to continue reporting robust growth.

"Because there was a scarcity of growth, they got a real premium," said Ross Yarrow, managing director of U.S. equities at Baird, about the Magnificent Seven during an interview with MarketWatch.

The tailwind from the artificial-intelligence craze didn't hurt, either.

To be sure, neither Kenwell at eToro nor State Street's Arone expect tech stocks to remain laggards for long. Most of the Magnificent Seven were expected to continue reporting strong profits growth, even if it looks less remarkable by comparison. This means they will likely rise alongside the rest of the market, instead of leading it higher.

Even if professional money managers cool to Big Tech, an army of eager retail investors likely stands ready to swoop in and buy at the first signs of any selloff, Kenwell said.

On the second trading day of October, U.S. stocks barely eked out gains as worries about an escalating conflict in the Middle East eased. The S&P 500 SPX rose by less than 1 points to finish at 5,709.54 on Wednesday, while the Nasdaq Composite COMP gained 14.76 points, or 0.1%, to 17,925.12.

The Dow Jones Industrial Average DJIA gained 39.55 points, or 0.1%, at 42,196.52.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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10-03-24 0730ET

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