Why the Mag 7 Trade is Far from Over: Chart of the Day

The Mag 7, comprising Meta, Amazon, Apple, Tesla, Alphabet, Microsoft, and Nvidia, have been the dominant force in the tech sector and the broader market for years. Their outsized influence on the S&P 500 and Nasdaq Composite indexes has raised concerns about systemic risks and reduced diversification. However, the growth and market capitalization of these tech giants suggest that the Mag 7 trade is far from over.



The Mag 7 companies have significantly outpaced the broader S&P 500 in growth and market capitalization. In Q1 2024, their profits are expected to grow by 38%, compared to the broader index's 10% growth (Wall Street CN). Their combined market cap of $12.5 trillion is over 30% of the S&P 500's total market cap, up from 20% in 2020 (Institutional Investor). This dominance, while raising systemic risks, also presents opportunities for investors.



Market cap-weighted indexes, such as the S&P 500, contribute to the Mag 7's dominance by allocating more capital to larger companies. As these tech giants grow, their market capitalization increases, leading to greater weight in the index and higher concentration in investor portfolios. This reduces sector diversity and increases correlation among these stocks, exposing institutional investors to more risk.

However, the Mag 7's earnings and revenue growth rates are a significant factor in their sustained influence. According to Wall Street CN, the Mag 7's earnings are expected to grow by 38% in Q1 2024, driven by strong performances from Apple, Amazon, and Google. This growth, coupled with their substantial market capitalizations, contributes to their disproportionate influence on the S&P 500 and Nasdaq Composite indexes.



Philip Seager, Head of Portfolio Management at CFM, notes that the Mag 7's outperformance is a statistical non-event in the long term. However, their concentration in tech and increased correlation pose systemic risks. Despite shifts in market cap, such as Berkshire Hathaway's approach, the Mag 7's tech concentration remains high, with NVIDIA's growth maintaining this trend.



The Mag 7's sector concentration, predominantly in technology, significantly influences the overall market's volatility and risk. As Philip Seager notes, the outsized market capitalizations of these stocks lead to greater weight in indexes, reducing sector diversity and increasing correlation among them. This concentration effect is not confined to the U.S. but observed globally, with the sheer size of the U.S. market amplifying the systemic risk.

In a market cap-weighted index, the Mag 7's performance disproportionately impacts the S&P 500 and Nasdaq Composite. In 2023, all the performance of the S&P 500 came from these stocks, as the rest of the index was flat. This high concentration and correlation expose investors to more risk in their portfolios, making true diversification challenging.



To mitigate the risks associated with Mag 7 stocks' correlation and concentration, investors can consider several strategies. One approach is to invest in sectors underrepresented in the Mag 7, such as healthcare, consumer staples, or energy. Another strategy is to allocate a portion of the portfolio to alternative investments like private equity or real estate, which have low correlations with traditional equity markets. Additionally, investors can explore smart beta strategies that focus on factors like value, size, or quality, which have historically shown lower correlations with market-cap-weighted indexes. Lastly, investors can consider using derivatives to hedge against market downturns or sector-specific risks.

In conclusion, the Mag 7 trade is far from over, as these tech giants continue to dominate the market and influence the broader economy. While their concentration in tech poses systemic risks, their growth and market capitalization present opportunities for investors. By adopting alternative diversification strategies, investors can mitigate the risks associated with Mag 7 stocks' correlation and concentration, ensuring a more balanced and resilient portfolio.