Opinion: A lopsided S&P 500 ain’t so bad

Richard Baker

I remember asking my high school baseball coach what we needed to do to win, and he said, “We need more Eddies!” Our baseball team consisted of Eddie, who was amazing, two above-average guys, and the rest of us, who wouldn’t make the team at many other schools. Coach was right; our baseball skills were lopsided, Eddie and then the rest of us. That is a perfect picture of the lopsided S&P 500 these days.

This year’s most popular investment discussion so far has been about the S&P 500’s Magnificent 7, which consists of Apple, Microsoft, Google, Tesla, Nvidia, Amazon and Meta. Often, investors speak of the S&P 500 as “the market.” If the index is that important, what about the other 493 stocks?

Performance picture
These Magnificent 7 stocks gained 70% in 2023, while the remaining stocks in the index were only up 6%. These are pretty lopsided returns for an index that’s supposed to represent such a broad part of the stock market. Should we be concerned?

Market strategists often discuss the benefits of a balanced market where the majority of the market concentration isn’t focused on a handful of companies. The reason is that when so few stocks (like these seven were last year) are responsible for up to two-thirds of the S&P 500’s performance, it could leave the market susceptible to a strong pullback if the few big guys stumble.

The S&P 500 going up is usually good news, but when just a few horses are leading, it could be masking some weakness with the rest of the index, but I don’t think it is this time. This isn’t the first time the Standard & Poor’s index has been lopsided. In the 1980s, IBM, Exxon and General Electric dominated, and the index made it through just fine, It will again this year.

Earnings factor
On the positive side, many believe the remaining 493 stocks could start to catch up this year, showing another gear for the market. For one, they are of better value. Looking at the price-to-earnings ratios (the lower the P/E ratio, the better the value), the 493 as a whole has a P/E ratio of 19, whereas the Magnificent 7 has a P/E of about 50. Secondly, since the 493 are smaller in size, they will benefit more from the falling dollar and lower interest rates and have more room to run than the big seven.

While I anticipate the Magnificent 7 will continue a strong performance this year, I also see potential opportunities in sectors that faced challenges last year, such as industrials, materials and transportation. These sectors, which struggled in the past, could present intriguing prospects for investors and market strategists.

Broaden exposure
It wasn’t that long ago that a person could just invest in an S&P 500 fund and have good diversification. These days, with the index’s lopsidedness, investors need to add specific small-caps and emerging market positions to broaden their exposure to the whole market.

Eddie went on to get drafted by the Chicago Cubs, and the rest of us, who never played baseball again, became professionals at other things. I’m hoping the 493 other companies hit their stride this year and start playing at the Magnificent 7 level.

Richard Baker, an accredited investment fiduciary, is the founder and executive wealth adviser at Fervent Wealth Management LLC in Springfield. He can be reached at richard@ferventwm.com.