Markets and Economy – Tipping the Scales: How the Market Grew So Top Heavy

by Tim Doyle, Chief Investment Officer, CFP®, MBA

In the Doyle household these days, it is all baseball all the time, at least until dreaded daylight savings begins in about a month.  You see, my oldest son caught the ‘baseball bug’ about a year-and-a-half ago, so when he isn’t at school and I’m not working, we’re usually in the backyard or at a local ballpark as he fields grounders, catches popups, takes batting practice, and rehearses little celebration routines that he is far too shy to ever demonstrate in practice or a game.  To be clear, this practice is entirely at his direction, and there isn’t a day where he doesn’t approach me after dinner asking, “hey Dada, you wanna go help me practice pop-ups?”  Truth be told, I absolutely dread the day when he outgrows this routine but, for now, I keep my glove nearby at all times.

He’s currently on a nine-year-old ‘fall ball’ team, and it’s fascinating to see kids entering different stages of physical development due to the age disparity across these teams.  Due to birthday cutoffs in these leagues, a 9u team may have some kids who are barely eight years old (like my son) while other kids are nearly ten.  This can make for some interesting matchups.  For example, at a game last weekend, I watched my son’s team warming up, and he’s got a handful of kids on his squad that could seemingly run between my legs without needing to duck.  Meanwhile, I glanced across the field to study our competition for the day, and I thought I saw one kid with a five-o-clock shadow and another twirling a thin mustache like he was a young Rollie Fingers.  “Did these kids drive themselves to the game?” I jokingly asked my wife.  Such differences in size and physical development can make for an interesting competitive landscape, to say the least.

This little league size disparity reminded me of a remarkable new dynamic we’ve seen develop across the stock market over the past five years.  Since 2020, there have been a select group of U.S. companies that have experienced an extraordinary growth spurt, as you can see in the chart below.

The above chart illustrates the market capitalization (market cap) of the Magnificent Seven stocks over the past ten years.  To add some perspective, I also included the market cap of eBay, which happens to represent the median market cap value for the S&P 500 index at a ‘mere’ $41.8 billion.  Market cap represents the total value of a publicly traded corporation and is calculated by multiplying the stock’s current market price by the number of shares outstanding.  As a company’s stock price rises, so does its market cap (assuming there is no change in outstanding shares). 

There was a time in the not-too-distant past when a $1 trillion market cap represented an almost unfathomable milestone.  At least, it seemed unfathomable until Apple surpassed the $1 trillion threshold in August of 2018.  As-of this writing, there are now nine companies with a $1 trillion market cap and three nearing or above $4 trillion in Microsoft, Apple, and NVIDIA.

Most of us can wrap our minds around what $1 million dollars represents, but it’s difficult to conceptualize $1 billion, let alone $1 trillion.  So, below is an anecdote to help everyone visualize the different levels of wealth we are talking about.

Anecdotes like this are interesting, of course, but you may be wondering what any of this means for investors.  Well, at a foundational level, the historic growth of these top 10 S&P 500 corporations has had a direct impact on two topics that are near-and-dear to the hearts of investment managers across the globe – risk and returns – and we’ll touch on returns first.

Getting Crowded at the Top

When we talk about ‘the stock market’ at Destiny Capital, we tend to refer to the S&P 500 index, as this index tracks the performance of the 500 largest publicly traded companies in the U.S.  It’s also important to stress that the S&P 500 index is ‘market cap weighted’.   This means that the larger the market cap of a company, the larger piece of the S&P 500 pie they represent.  As an example, back in 2022, NVIDIA represented roughly 1% of the S&P 500 index.  Since then, the company’s stock has experienced staggering growth and its market cap has risen above $4 trillion.  Therefore, NVIDIA now represents roughly 8% of the S&P 500 index overall.

What’s so unusual about the stock market today is how concentrated the S&P 500 has become among its top 10 stocks due to the market cap growth illustrated previously.  As you can see in the chart below, the top 10 stocks in the S&P 500 represent a record high FORTY percent of the index as a whole.  For some perspective, back in 2015, the top 10 holdings of the S&P 500 represented about 17% of the entire index, and included old stalwarts like GE, Johnson & Johnson, Exxon and Procter & Gamble.  That seems like a lifetime ago, doesn’t it?

Source:  JP Morgan Asset Management Guide to the Markets

If you’ve read any of these investor letters since around 2021, you’ll know that we’ve referenced the Magnificent 7 stocks ad nauseum.  This is because performance of the S&P 500 index (the ‘market’) has been so dependent on these select few companies over this period.  For example, in 2023 and 2024, the Magnificent 7 stocks produced combined annualized returns of +76% and +48%, respectively.

Meanwhile, over that same time period, the ‘rest’ of the S&P 500 produced combined annualized returns of just +11% and +14%.  The point is – if an investor’s portfolio didn’t have exposure to all or some of the Magnificent 7 stocks in recent years, portfolio returns likely suffered because of it.

Earnings Growth & Artificial Intelligence

Why have these seven stocks attracted investors at such historic levels?  Well, it largely has to do with two things – earnings growth and artificial intelligence.  When it comes to earnings growth, the Mag 7 stocks have produced some lofty numbers in recent years, as you can see outlined below.

To add some perspective, the S&P 500 has experienced an average, annualized earnings growth rate of about 6.3% since the year 2000.  So, given such attractive earnings growth rates, it’s not difficult to see why these stocks have garnered such fervid investor interest.  The other reason for this investor attention, as mentioned previously, has been the advent of artificial intelligence (AI) technology.

November 30, 2022 was a date that almost immediately disrupted the trajectory of financial markets and the mindset of investors.  No, November 30th wasn’t the date of some important Fed meeting or when some new tax law was passed, but was the launch date of ChatGPT, the advanced AI language model from OpenAI.  ChatGPT captured the imaginations of the investing public and helped to demonstrate the potential for how truly impactful and disruptive this new technology could be. 

The chart below helps to illustrate the impact of this new technology, as it almost immediately changed the path of industrial production across the United States.  Suddenly, production of semiconductors, communication equipment, and computer equipment soared while all other industrial production remained flatlined.

Source:  JP Morgan Asset Management Guide to the Markets

This level of industrial production has largely been driven by significant capital investments from AI hyperscalers (and Mag 7 members) like Alphabet, Amazon, Meta, and Microsoft.  To provide some perspective on how much has changed in recent years, the AI hyperscalers invested roughly $123 billion in AI buildout back in 2022.  By 2027, that figure is expected to increase to $467 billion. 

Furthermore, we’ve seen AI adoption accelerate across businesses, particularly in sectors like information technology, professional & technical services, and finance & insurance, as you can see in the chart below.  By early 2026, it is projected that over 35% of all information technology companies will be utilizing AI to produce goods and services.

So, to review what we’ve learned so far – we’ve seen market valuations of the Mag 7 stocks soar in recent years, and this has largely been driven by very strong earnings growth and the potential for these companies to be leaders in AI technology.  Generally speaking, those are all positives for investors, but what are the new risks that are emerging due to such accelerated market cap growth?

Emerging Risks

This remarkable rally has led to a top heavy S&P 500 which has introduced some unique challenges for investment managers over the past two years.  Never in the history of the modern stock market have we seen such concentration at the top of the S&P 500.   For example, for every $100,000 invested in an S&P 500 index fund like SPY, VOO or IVV, roughly $40,000 will be allocated to ten individual stocks.   Therefore, now more than ever, it’s important for investors to look under the hood of their portfolio to understand what they own and why. 

Why is this important?  Well, to continue the baseball analogy from earlier in this letter, it can be nice to have a few kids on your son’s 9-year-old team who both look and play like freshmen in high school.  Little ‘ringers’ can lead to a lot of runs and some easy wins.  However, just like with investing, there’s the potential for concentration risk, and what happens when little Mickey Mantle IV takes a Disney vacation with his family and misses a few games?  Suddenly, your team looks more like the Bad News Bears than the Yankees Triple-A team.

As it stands now there’s the potential concentration risk at the market level (a top-heavy S&P 500), the sector level (technology) and the strategy level (AI).  Therefore, investors have grown increasingly reliant on these top mega cap technology companies to meet and exceed earnings expectations in order to drive returns.  What happens when one or more of these companies falter? 

Well, we only have to look as far back as three years ago to learn a brief and important history lesson.  In 2022, the Magnificent 7 stocks sold-off, on average, -46% in one calendar year and dragged down the performance of the S&P 500 index as a whole.  This can be seen in the chart below.

At Destiny Capital, our investment committee is constantly monitoring the underlying holdings across each and every portfolio.  As we’ve outlined previously, it’s been important for investors to have some exposure to these top stocks as they’ve been the primary drivers of performance of the stock market as a whole.  However, as the old Colorado saying goes, it’s important “not to get too far out over your skis” when it comes to concentration risks, as this can lead to portfolio imbalances that can trip-up investors.

This also helps to stress why, at Destiny Capital, we focus so much on portfolio diversification.  We want to own a variety of asset classes with unique characteristics that behave and perform differently across the market cycle.  This helps to keep clients invested over the long run and weather volatility when it inevitably strikes. 

The Government Shutdown & Economic Blind Spots

You may have noticed that I have yet to mention the U.S. government shutdown and its potential impact on the U.S. economy and financial markets.  This is because, right or not, investors have grown accustomed to shrugging off whatever is happening in Washington D.C. in recent years.  Most investors assume that a deal will eventually be reached and the government will reopen after some prolonged public posturing by each party.  Could there be an economic impact if the shutdown lasts many weeks or months?  Of course.  According to past research by Goldman Sachs, a government shutdown could drag economic growth by 0.15%-0.20% per week.  It is also expected that this shutdown will impact roughly 750,000 government workers as they are placed on unpaid leave.  The longest government shutdown came back in late 2018 and lasted 35 days.  The Congressional Budget Office (CBO) estimated that this shutdown reduced GDP by about $11 billion with roughly $3 billion in losses that were unrecoverable.

However, one crucial aspect of this shutdown that doesn’t often get a lot of headlines is the fact that economists and investors are now operating with blind spots due to the lack of collection and publication of crucial economic data.  A government shutdown means no labor market data, no inflation data, no GDP data, no housing market data, no retail sales data and more.  This comes at a time when the Federal Reserve is expected to make vital monetary policy decisions that are heavily reliant on this data. 

Clearly, that is far from ideal at such a pivotal time for the U.S. economy with the labor market weakening and inflation rising.  Of course, the Fed can operate with alternative data sets and proxies, but the shutdown inserts a bit more uncertainty into their outlook which, in turn, adds a bit more uncertainty for investors.  As we all know, uncertainty can potentially lead to stock market volatility.  As always, we’ll keep you updated as circumstances around the shutdown change, and please don’t hesitate to reach out to your dedicated team if you have any questions, even if you’re just curious about your potential exposure to the top S&P 500 stocks reviewed today.

Important note and disclosure: This article is intended to be informational in nature; it should not be used as the basis for investment decisions. You should seek the advice of an investment professional who understands your particular situation before making any decisions. Investments are subject to risks, including loss of principal. Past returns are not indicative of future results.  Advisory services offered through Destiny Capital Corporation, an Investment Adviser registered with the U.S. Securities & Exchange Commission.

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