A Purposeful Pause


The Flyover:

Things are rarely ‘new’ in this world and that includes this latest rendition of “The Magnificent Seven”.  The good news is that history is on our side for what likely comes next.

In 1960, the Western movie “The Magnificent Seven” was a big hit.  Successful enough that three sequels were produced in 1966, 1969, and 1972.  All this just happens to be adapted from something originally out of Japan in 1954 (Seven Samurai).  My point is, nothing seems to ever truly be new anymore. 

Case in point, we now have yet another version of The Magnificent Seven dominating the scene.  This time around there is no Yul Brynner or Denzel Washington.  Instead, there is a Tim Cook and a Jen-Hsun Wong.  This modern-day version of the Magnificent Seven is the nickname given to the small number of stocks providing the vast majority of the returns for the overall market index. Specifically, Apple, Nvidia, Microsoft, Meta (Facebook’s parent), Amazon, Tesla, and Alphabet (Google’s parent). 

Depending on the day you measure, this handful of stocks accounts for 80%, and in some cases, as much as 95% or more, of the broad market’s total return for the year so far.  Clearly these few stocks have done well after being hit among the hardest last year.  The other 493 stocks that make up the S&P 500, however, have essentially done nothing at all. 

Quite literally, if you removed these 7 stocks from the index, you’d see a return of nearly zero.  But since the S&P is a market cap weighted index, these behemoths have an outsized impact. So much so that when you add them back to the full index, these 7 stocks alone take that near zero return close to 14% as I write this note. 

Another way to see this is to look at an equal weighted index, where each of the 500 stocks contribute the same amount to the calculations.  Do this and you’ll see a return of roughly 4%, proving this year’s story has been all about this narrow collection of companies.  As they have raced ahead, small and mid-cap stocks are largely unchanged, and the other 493 stocks that make up the large-cap category have barely nudged ahead.  This is very unusual and is not sustainable.  The big question is: what does this dichotomy mean?

This situation, though uncommon, isn’t without precedent.  We’ve seen small groups of stocks run far ahead of the pack temporarily in the past.  These periods always sunset.  Always.  There’s simply no scenario in which a small cohort becomes the proxy for the entire economy and continues behaving at odds with the majority.  This leaves just two ways by which these phases resolve themselves: either the current leadership fails and falls back to the pack, or the current leadership stalls and all their brother, sister, and cousin companies play catch-up.  This second outcome is historically more common, and I’d anticipate this to be how things play out this time, too. 

Think of it this way.  These handful of stocks have ventured ahead of the pack on somewhat of a reconnaissance mission.  They’ve poked their heads over the economic fence to see if the world is still on its axis.  They have a look at things like consumer’s actions, business balance sheets and earnings prospects, expected inflation shifts, and more.  If they have a look at the landscape and feel safe, they wave up the rest of the platoon.  If they look around and don’t like the scenery, they retreat to the safety of the larger group. 

It’s my opinion that they are proving the coast is clearer than the average pundit fears.  These seven companies, by nature of what they produce, are arguably more in touch with both the consumer and the general level of business activity than most.  Thankfully it hasn’t been just their stock prices that have been rising, but also their earnings. 

While these points auger well for a continued recovery in the economy and the financial markets, we need to recognize that we’ve entered a plateau phase.  Yes, the pause button has been hit on our Magnificent Seven movie marathon.  

That’s perfectly normal and healthy.  Especially now as it lends credibility to the very notion of current leadership stalling and setting the stage for the rest of the stocks in the index to close the gap.  In recent weeks, quiet as it may be, this is precisely what is happening.  We’ve seen the Magnificent Seven languish and, in most cases, retreat 10-20%, while the laggards have crept ever so slightly forward.  This is how the movie continues once the play button has been pressed, which is typically after a few months of slightly lower price action.

Add ‘seasonality’ to the mix and my expectation is for the market to dip a bit further before stabilizing and moving higher.  By this I mean that the August to October period tends to be weak, for mostly immaterial reasons. 

It’s foolish, and ultimately costly, for investors to fear plateau phases.  They are needed to wring out excesses, avoid bubbles, and create value.  Plateaus and pullbacks place consequences on bad decisions by businesses and investors alike, which are necessary guardrails in the world of finance.  They aren’t fun to sit through, but they are necessary and inevitable.  They simply don’t suggest that anything is ‘wrong’. 

Even as I believe the markets are likely to pull back a bit from here, remember the adage that Wall Street climbs a wall of worry.  Brace yourself for the onslaught of negativity the press will promote.  Remember that nothing sells like fear, and the news outlets all need to sell advertising.   As a result, every correction in the market is sensationalized as if it portends the end of the world. 

Accompanied by all the dire predictions of doom and despair, I’d suspect any impending pullback will be shallow and refreshing.  Do your best to recognize the profiteering ploys of the financial press and instead remember some factual data that tells the clearer story. 

Namely, recent economic data has been pleasantly resilient.  Two of the better indicators pack a lot of positivity – last month’s retail sales figures were twice the anticipated amount, and industrial production numbers were three times higher than expected.  These data points don’t mean markets don’t slump from time to time.  But they are well worth keeping in mind as to why we’ll have a pause and not necessarily a problem.

The Takeaways:

  • Everything old is new again, so now we have a new take on The Magnificent Seven.
  • History suggests that as these leaders continue to pause, good things come to the market overall, but not likely before a little more time in a plateau or relatively modest pullback phase.
  • After an expected few months of rest for stocks, they’re likely to fare better than most assets looking out on the horizon.  That means they’ll likely outpace Treasuries, CDs, corporate bonds, commodities, the real rate of inflation, and even real estate.  
  • Don’t be discouraged by a healthy plateau phase.  If anything, recognize its value and be confident in its outcome. 


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