By William Sanders and Matthew Bencivengo, Interns
The companies comprising the S&P 500 and the Magnificent Seven include many that have invested heavily in AI. What does this mean for investors?
As current high school students, we have been given a blessing, and at times a curse, of a tool called ChatGPT. ChatGPT is an online virtual assistant that allows users to type in some basic research words and phrases and be given a series of solutions. Two times over the past 12 months ChatGPT has been a great resource for us.
First, Will attended a pre-college program at the School of New York Times, taking a class called ‘Million Lives In Law’. At the end of the program, he was tasked with presenting a law that was supposed to improve his community where he lives in Vermont. However, he could not think of a catchy headline for the law – enter ChatGPT. In a matter of seconds after inputting search criteria, Chat GPT gave ten options, a few of which were: “Housing for All: Vermont’s Affordable Living Solution”, “Turning Keys, Changing Lives: Vermont’s Affordable Housing Act”, “From Blueprint to Reality: Vermont’s Affordable Housing Vision” and “A Roof for Every Vermonter: Advancing Affordable Housing”. In the end, From Blueprint to Reality: Vermont’s Affordable Housing Vision made the cut.
Second, during the final two weeks of the school year, Matt wanted to redesign his study schedule to appropriately prepare for exams – enter ChatGPT. He gave the AI tool his daily wake up, gym and bedtime schedule, a list of classes ranked from easiest to hardest, his afternoon activities and free blocks during the day, followed by the sentence, “Work around these mandatory events to prioritize and maximize my study schedule for efficiency and effectiveness based on the criteria that I provided.” ChatGPT delivered a study schedule that put classes he found harder in slots during the day where extra time existed, and easier classes in slots where he had less time.
At the time, neither of us realized how far AI expands beyond just a headline or a study schedule and that it would begin to assist major companies in dominating the market. Many of these companies are household names and have been referred to “The Magnificent 7”.
The Magnificent 7:
The Magnificent Seven include Meta Platforms, Amazon, Apple, Netflix, Alphabet, Microsoft, and Nvidia. They all rode the hype of AI by applying it to their own products. In 2023, Alphabet Inc. had a stock increase of 58%, Amazon Inc. 81%, Apple Inc. 48%, Meta Platforms Inc. 194%, Microsoft Corp. 57%, and NVIDIA Corp. 239%. The unrivaled growth of these stocks has had market wide implications for investors, especially in the S&P 5001.
The S&P 500:
The S&P 500 is a weighted average of the top 500 publicly traded stocks on the New York Stock Exchange. The Magnificent Seven stocks drove the performance of the S&P 500 in 2023 and 2024 (YTD). They accounted for one third of the S&P 500’s 16% growth in 2023. In March 2024, the Magnificent Seven held 33% of the total S&P 500 market capitalization, totaling around 14 trillion USD2.
Concentration:
The concentration of the S&P 500 in these seven companies poses an increase in risk for investors. Economic concentration refers to a situation where a small group of businesses wield disproportionate influence over a market. The S&P 500 market is currently highly concentrated because the Magnificent Seven have significant control over it. In fact, the S&P 500 now has its highest level of economic concentration in 50 years. Since the S&P 500 is highly concentrated, its performance depends increasingly on only the Magnificent Seven. Therefore, investments in the S&P 500 carry more risk than they have traditionally. We can best understand the implications of today’s S&P 500 concentration by examining two textbook examples of market concentration in the past.
Case Studies:
Example 1: The ‘Nifty Fifty’
The ‘Nifty Fifty’ stocks are a classic example of how market concentration can affect an index. From the 1960s to the 1970s, the S&P 500 was dominated by 50 blue chip, large cap stocks on the New York Stock Exchange. Some notable companies included IBM, Polaroid Corporation, Coca-Cola, McDonald’s, Walt Disney, and Johnson & Johnson. In 1973 the S&P 500 had the highest level of market cap concentration since the Great Depression. In addition, these stocks had strong return rates, often more than 15%. However, an oil crisis in the Middle East, along with unemployment and inflation, crushed the economy and the S&P 500 as stocks lost 50% of their value, showing the vulnerability of a concentrated economy. Revered blue chip stocks such as Xerox dropped 68% and Polaroid dropped 90%. It would take six years for the index and wider economy to recover3.
Example 2: The Dot Com Bubble
The dot com bubble, a period of rapid investment in technology from 1998-2000, had many companies ride the hype of the internet to the top of the stock market. The growth of technology companies led to significant market consolidation. However, these technology companies had no profit and very high valuations, so as investment capital dried up, these companies failed, and the market crashed. As a result, many indexes plummeted, such as the S&P 500, which lost about 49% of its value during that time frame4.
What Can I do?
To mitigate the novel risk posed by the concentrated S&P 500, investors can further diversify their portfolios. Investing in vehicles that track sectors with a low correlation to technology and AI would help abate the risk in the S&P 500. Additionally, investing in individual securities of companies with little relation to AI would provide more diversification and risk mitigation as well. Although, if you have time and a tolerance for risk for owning stocks, the second strategy that investors can utilize is a simple one: hold. A Goldman Sachs research study found that “The S&P 500 rallied more often than it declined during the 12 months following past episodes of peak concentration” underscoring how a concentrated S&P 500 can be good for investors5.
In Conclusion:
While historic precedents do not provide a single narrative for the short-term behavior of the S&P 500, they do provide a compelling long term message: growth. The S&P 500 has always rallied in the long term. If one had invested $1,000 in the S&P 500 before the Great Depression, he or she would have $517,233.32 now, and if one had invested $1,000 in 1972, it would be worth $173,000 today. It can be beneficial for investors to recognize that the S&P 500 carries more risk than usual. Luckily, there are options available, including diversification in non-AI stocks and indexes or holding on to the S&P 500. In addition, it is important to recognize the level that Gen Z relies upon AI to do our work, receive streamlined services, and maximize our time. So, AI is likely the future, not a fad. At the end of the day, however, you should feel confident in your wealth manager’s plan for you and the vitality of the long term investment horizon of the S&P 500.
Footnotes:
- CNN, last modified June 10, 2024 – https://www.cnn.com/cnn-underscored/money/magnificent-7-stocks
- “Is the S&P 500 too concentrated?,” Goldman Sachs, last modified March 21, 2024 – https://www.goldmansachs.com/intelligence/pages/is-the-sp-too-concentrated.html
- “Nifty 50 Share Price,” Upstox, last modified June 12, 2024, accessed June 12, 2024 – https://upstox.com/indices/nifty-50-share-price/
- Kevin Mercadante, “A Timeline of the Biggest Stock Market Crashes in U.S. History,” Time, last modified June 6, 2024- https://time.com/personal-finance/article/us-stock-market-crashes/#:~:text=The%20Dot%2Dcom%20bubble%20burst,meltdown%20of%202007%20to%202009&text=I%20would%20argue%20that%20this,NASDAQ%20dropped%20an%20incredible%2075%25
- “Is the S&P 500 too concentrated?,” Goldman Sachs – https://www.jpmorgan.com/insights/global-research/markets/market-concentration