CONTRIBUTORS
Alex Lee, CFA, CAIA, MFin
Head of Canada ETF Product Strategy
Franklin Templeton Canada
Through the first half of the year, S&P 500 Index returns have been significantly boosted by the Magnificent (Mag) 7 with momentum from 2023 continuing on back of strong earnings growth. Leading the group is Nvidia, which briefly became the world’s largest company by market cap in June, before Microsoft reclaimed the crown.
As a group, they collectively returned 32.8% (USD) as of June 30, 2024, in comparison to just 8.3% for the other 493 companies in the S&P 500 Index. This divergence away from the rest of the market has raised questions about the sustainability of such a highly concentrated rally, as the Mag 7 contributed close to 60% of the return for the S&P 500 Index.
Comparison: Mag 7 Continues to Outpace the Rest of the S&P 500 Index
Source: Bloomberg L.P., as of June 30, 2024. All returns in U.S. Dollars as total returns. Past performance is not a guarantee of future results. Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges.
With recent headlines broaching the onset of a possible rotation out of mega cap growth stocks, investors are wondering whether it makes sense to lock in their gains and look elsewhere for growth. We’ve taken the time to dig into the numbers and analyze the performance of U.S. equities during the opening half of the year based on sector and major factors in the S&P 500 Index.
U.S. Sectors: Performance Analysis (USD)
As of June 30,2024
Ten out of eleven sectors finished positive during the first half of 2024 led by technology (28.2%) and communication services (26.7%). While these two sectors have received the most attention, it’s worth noting the changing dynamics taking place outside of them.
Tech is Dominating, but Changes Happening Underneath
Source: Morningstar Research Inc., as of June 30, 2024. All returns in U.S. Dollars as total returns. Past performance is not a guarantee of future results. Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges.
Utilities, consumer staples and health care had better returns year-to-date, compared to last year’s lackluster performance. Utilities were a bright spot among defensive sectors with a gain of 9.4% as Constellation Energy and NRG Energy ranked among the top ten best performing stocks in the S&P 500 Index during the first half of the year.
Consumer discretionary failed to repeat last year’s success as Tesla, McDonald’s, Nike, Starbucks, and Lululemon each struggled with double digit losses. The real estate sector finished at the bottom as the only negative sector while materials also struggled with a gain of 4.1%.
Gains are still heavily concentrated in technology and communications which house most of the Mag 7, but there have been improvements in some of the sectors that struggled during last year, including utilities and energy. This suggests that it’s important for investors to consider stocks beyond just last year’s winners.
U.S. Factors: Performance Analysis (USD)
As of June 30,2024
The S&P 500 Index returned 15.3%, compared to 5.1% for the S&P 500 Equal Weighted Index, as top ten stocks accounted for over 70% of returns. The higher weighting of the top ten stocks and the lack of breadth from the market has been topical through the first half of the year.
Momentum is Driving Performance
Source: Morningstar Research Inc., as of June 30, 2024. All returns in U.S. Dollars as total returns. Past performance is not a guarantee of future results. Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges.
The Momentum Index led the first half with a gain of 34.0%, followed by the Growth Index (23.6%) and the Quality Index (18.3%). These were the only three major factors we track that outperformed the S&P 500 Index during this period.
At the end of June, the top stocks in the Momentum Index were Nvidia, Apple, Microsoft, Meta, Amazon, and Broadcom, with 50.3% allocated to the technology sector, representing areas of the market that have seen stellar returns this year.
The Dividend Aristocrats Index and the High Dividend Index finished near the bottom, along with the Low Volatility Index. The S&P 500 Dividend Aristocrats Index requires companies to consistently increase dividends for at least 25 consecutive years, thus lacking many growth stocks without a long history of dividend payments.
Outside of Momentum, Growth, and Quality Index, many of the factors had disappointing returns during the first half, especially factors that lacked exposure to the Mag 7 stocks.
So…What Comes Next?
The Mag 7 companies are at the forefront of technological innovation, and the strong competitive edge in many of the emerging technologies allows these companies to maintain stout growth and leadership. The narrowed market return is not historically unique as themes emerge that change the composition in the S&P 500 Index throughout history. However, there are burgeoning opportunities outside of these seven names, especially if earnings start to improve for the rest of the market.
Mag 7 Earnings Gap Expected to Narrow
Magnificent 7 data refers to the following set of stocks: Microsoft (MSFT), Amazon (AMZN), Meta (META), Apple (AAPL), Google parent Alphabet (GOOGL), Nvidia (NVDA), and Tesla (TSLA). Sources: FactSet, Russell, S&P. as of June 30, 2024. Past performance is not a guarantee of future results. Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. There is no assurance that any estimate, forecast or projection will be realized. Company references are used for illustrative purposes and should not be construed as an endorsement of sponsorship of Franklin Templeton companies. This information is not intended as an investment recommendation, nor does it constitute investment advice.
However earnings might unfold, the Mag 7 represent a substantial part of the U.S. equities, having grown its weight in the S&P 500 Index from 20% in 2022 to over 32% today. This means that – for better or worse – they stand to have an outsized influence on the future of the index. With that in mind, let’s look at three strategies as you weigh the role of this important cohort in your portfolio.
ETFs For Every Possibility
Mag 7 Weightings: S&P 500 Index vs Franklin ETFs
Source: Bloomberg L.P. and Franklin Templeton, as of June 30, 2024. The green box indicates higher security weight relative to the S&P 500 Index, and the red box indicates lower security weight relative to the S&P 500 Index. Past performance is not a guarantee of future results. Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. Company references are used for illustrative purposes and should not be construed as an endorsement of sponsorship of Franklin Templeton companies.
Embracing Innovation With the Mag 7 – Franklin Innovation Fund (FINO)
FINO invests in the Mag 7, but it also invests in other fast-growing companies looking to advance general-purpose technologies shaping our future. Think of things like AI, robotics, and genomics. New developments in these fields will create new winners in the market, while also compounding the value of previous technologies by unlocking new potential and efficiencies. We believe FINO is ideal for investors seeking growth exposure in their portfolios with tremendous opportunities stemming from the Fourth Industrial Revolution, which is still in early innings. Learn more.
Embracing the Core With the Mag 7 – Franklin U.S. Large-Cap Multifactor Index ETF (FLUS)
The Mag 7 is a core part of the U.S. equity market, and can’t be ignored as they represent almost a third of the weight of the S&P 500 Index, but we also value the importance of weighting individual stocks with a fundamental bias.
FLUS employs a rule-based multi-factor approach, providing exposure to Magnificent 7 stocks today with three well-known factors: 40% Quality, 30% Value, and 30% Momentum. Stocks in the Index compete for a spot and a higher weight on a quarterly basis, which helps reduce stale weights and adds the tactical element. Learn more.
Complementing the Mag 7 – Franklin U.S. Low Volatility High Dividend Index ETF (FLVU)
Maybe you’re looking to rebalance or diversify away from the Mag 7. As I’ve outlined, defensive sectors have been improving, and could be a great complement to your Mag 7 holdings. FLVU's defensive sector weights and robust dividend yield relative to market-cap-based indices offer an appealing counterbalance to the concentration in the top weights in U.S. equity market. FLVU employs a screening process that targets not only high dividend yields, but also emphasizes profitability to ensure dividend sustainability.
This strategy is also available for clients seeking equity exposure to both Canada (FLVC) and Developed International Markets equities (FLVI). Learn more.
Final Word
The breakout of the Mag 7 has been notable given both the impressive performance and earnings growth since last year stemming from innovation and market leadership.
I believe the AI market will continue to grow and expect adoption of AI to continue as capabilities improve, which will be a principal element for investors to consider long-term. However, I also recognize opportunities outside of AI and big data, which excites me about the ETF solutions we’ve covered.
I believe it’s important to be selective on the weighting of these stocks, either from the lens of active or smart beta, with fundamentals in mind. Moreover, diversifying into other areas of the market to complement either growth or core style investments also seems sensible. As we move through the second half of the year, I’ll be closely watching earnings from the Mag 7. But I’ll also be focusing on how emerging innovations might challenge or supplant index leaders, as we’ve seen in the past.
IMPORTANT LEGAL INFORMATION
Alex Lee’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinion, and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
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