Is the Magnificent Seven’s dazzling stretch of outperformance finally coming to an end?

A Wall Street Veteran's Perspective

According to Richard Bernstein, chief investment officer of Richard Bernstein Advisors, it may be time for investors to seize a "generational buying opportunity" in unloved areas of the global stock market. Bernstein suggests that these sectors could surpass U.S. market leaders like Apple Inc. and Nvidia Corp. in the coming decade.

Drawing Parallels

Bernstein draws a comparison with the period between the bursting of the dot-com bubble in the early 2000s and the arrival of the 2007-2009 financial crisis. During that time, the S&P 500 index and technology stocks underperformed, while "underdog" areas of the market, such as the energy sector and emerging-market equities, thrived.

"Much like after the deflation of the Technology Bubble, investors could be facing another 'lost decade in equities,'" stated Bernstein.

Evaluating Valuations

The foundation of Bernstein's view lies in the extreme valuation gap between the top-performing U.S. megacap stocks and the rest of the market. As illustrated in the chart below, as of late October, the seven most valuable U.S. publicly traded companies were more than twice as richly valued as much of the rest of the global equity market, based on price-to-earnings ratios.

"Profits and valuation, when combined with investors' myopic views on the Magnificent Seven suggest a generational investment opportunity in the broader global equity markets," emphasized Bernstein.

The Magnificent Seven

The so-called "Magnificent Seven" refers to a group of seven megacap U.S. stocks: Apple, Microsoft Corp., Google owner Alphabet Inc. (both Class A and Class C shares are typically included), Inc., Nvidia, and Meta Platforms Inc., the parent company of Facebook and Instagram.

The Mag 7: Driving the Market Rally

The "Mag 7" stocks have been a driving force behind the impressive market rally of over 60% this year, based on a market-capitalization weighted analysis using FactSet data. These seven stocks have single-handedly accounted for nearly all of the S&P 500's year-to-date advance, offsetting the losses experienced by the other 493 index members.

The current rally in U.S. equities has been heavily reliant on these large-cap stocks, leaving much of the rest of the market lagging behind. Small-cap stocks, in particular, are still in negative territory for the year.

According to FactSet data, the S&P 500 has surged more than 13% this year following last week's rally. However, U.S. small and midcap stocks have struggled to keep up with the S&P 500 and the technology-dominated Nasdaq-100, which has benefited the most from the outperformance of the Mag 7.

Looking beyond the U.S., emerging-market stocks have generally underperformed, despite a few areas of strength.

Is it Time to Reconsider Non-U.S. Equities?

See: International equities are beating U.S. stocks in 'rare' outperformance. Should you lighten up on non-U.S. equities?

See: Emerging-market stocks are looking cheap, especially relative to the U.S. Does that mean it is time to buy?

Although a global stock index has closely tracked the performance of the S&P 500, an equal-weighted version of the S&P 500 tells a different story. This alternative approach gives equal importance to each member stock, regardless of their market value. Before last week's rebound rally, this equal-weighted index was slightly down for the year after experiencing a decline of over 4%.

As U.S. stocks witnessed their best week of 2023, there were indications that a rotation in performance, as anticipated by Bernstein, might already be in progress. Notably, small-cap stocks outperformed the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average—an uncommon occurrence in recent times.

According to Dow Jones Market Data, the Russell 2000, a popular small-cap index, recorded its best weekly gain since 2021, surging over 7% last week.

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