S&P 500 Equal-Weight Index May Surpass Performance of Magnificent Seven Stocks

The S&P 500 equal-weight index has shown remarkable performance post-1999, and new analysis indicates it could be poised for similar success again.

As the dominant Magnificent Seven stocks continue to lead the equity market, concerns are growing regarding their sustainability. Historical data points to a potential decline in their outperformance.

Glenmede Investment Management's analysis reveals concentration levels in the top 10% of US stocks now parallel those of 1929 and 1999, unprecedented peaks linked to significant market bubbles.

Portfolio manager Alex Atanasiu, representing a firm overseeing $6.6 billion in assets, warns that this bodes poorly for the largest stocks in the market and, consequently, for the cap-weighted S&P 500 index.

Currently, the average market capitalization of the top 10% of US stocks compared to those between the 30th and 70th percentiles is three standard deviations above normal. Investors are heavily investing in AI-related stocks.

Historically, during times of high concentration, the top 10% of stocks yielded negative returns over the subsequent three to five years, while the average stock in the middle percentile saw returns of 50% to 69%.

Atanasiu emphasizes the growing divide, stating, "It's a tale of two markets." He suggests that while a crash may not be imminent, returns for the top decile are likely to stagnate, with the broader market faring better.

To further illustrate market concentration, Atanasiu compares the cap-weighted S&P 500 index with the S&P 500 equal-weight index, which treats all constituents equally. Historically, the equal-weight index has underperformed, currently sitting 37% below its relative performance trend against the cap-weighted index, a situation only slightly more severe than in 1999.

After 1999 downturns, the equal-weight index embarked on an impressive five-year rally, outperforming the cap-weighted index annually by over 10%.

Atanasiu’s predictions align with sentiments from other major financial institutions. Goldman Sachs anticipates a 3% annual return for the S&P 500 through 2034, influenced by the current Shiller CAPE ratio. Similarly, Morgan Stanley predicts "flat-ish" returns, while Rob Arnott foresees a bear market for large-cap stocks with value stocks thriving.

Arnott pointed out the drastic shift from March 2000 to March 2002, where the S&P dropped 27%, while Russell 2000 Value soared by 53%. "When valuation gaps get wide enough, markets can utterly disconnect," he explained.

In the latest market shifts, recent announcements like the DeepSeek R1 chatbot's release have reflected this tension. The emergence of cheaper AI models has unsettled tech stocks, while value-based investments like the Vanguard Value Index Fund ETF (VTV) have remained steady.

Atanasiu concludes by noting the evolving landscape of AI investments, stating, “You never had any price pressures on AI. Now you're seeing some cost pressures, which may prompt a reassessment of projected earnings growth.”