Are The Market's Biggest Stars About to Lose Their Shine?

For the past two years, the 10 largest U.S. stocks have been the primary drivers of market returns. However, with signs of shifting performance patterns, investors should revisit what happened after previous periods of concentrated market dominance.

These leading stocks have often been market stars, but their shine tends to fade in bear markets. Asset management firm AllianceBernstein reviewed the past 30 years, identifying four periods when the top 10 stocks dominated:

1996: A favorable combination of economic and market conditions led to significant representation of technology and healthcare companies among the top 10.

1999: Three years later, the dot-com bubble fueled extraordinary returns for the top stocks, with tech again making up a large portion.

2020: Tech stocks took the lead once more, but this time, the COVID-19 pandemic accelerated adoption of digital services, e-commerce, remote work, and cloud computing.

AllianceBernstein cautions that holding the top 10 stocks by benchmark weight can carry substantial risk, but underweighting them also comes with potential pitfalls.

This warning is supported by data from Goldman Sachs. As of Q3 2023, the average large-cap mutual fund underweighted the Magnificent 7 by 806 basis points relative to the benchmark index. Consequently, only 31% of large-cap mutual funds outperformed the benchmark this year. Funds that were underweight in these tech giants generally underperformed, as illustrated in recent trends.

What Happens Next?

Historically, during these periods of concentrated market leadership, the broader S&P 500 often outperformed the top 10 stocks—even in two instances when the overall market declined.

Looking ahead, the growth prospects for these tech giants are expected to slow. UBS projects that in 2024, the earnings-per-share growth gap between the Magnificent 6 (excluding Tesla) and non-tech stocks will narrow to just 5%, down from a peak gap of 60%.

UBS analysts also warn that these mega-cap companies face risks of overinvestment. Many are key customers for semiconductors, particularly in AI. If these companies begin underperforming, they could cut capital expenditures, negatively impacting their suppliers.

Conclusion

Both UBS and AllianceBernstein agree on one point: Investors should not blindly rely on market leaders. Instead, decisions should be based on the intrinsic value of each stock, emphasizing a balanced and diversified investment approach.