Over the last 18 months, Magnificent Seven stocks have dominated markets’ performance and narrative ad nauseam. For a while, it felt like nothing could stop their march forward, and they would defy gravity for years to come. But in markets, like in life, nothing is forever.
writes Pierre Debru, Head of Quantitative Research & Multi Asset Solutions, WisdomTree
On 10 July, Magnificent Seven stocks may finally have met a worthy opponent in the form of a strong Consumer Price Index (CPI) print. Since the Bureau of Labor Statistics published a lower-than-expected CPI at +3% year-on-year and core CPI at +3.3%, markets appear to have finally pivoted. In the space of a week, the Russell 2000 jumped 9.2% while the Nasdaq lost -4.2%. In the same period, the S&P 500 equal weight outperformed the S&P 500 by 4.3%.
This rotation away from Magnificent Seven stocks and towards smaller caps, while impossible to predict in terms of the timing or magnitude, has been a long time coming. We believe a few catalysts may be aligning, leading to the establishment of a wider and longer trend in which the market broadens, the remaining 493 stocks in the S&P 500 as well as small caps rebound and play catch-up with the Magnificent Seven.
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The Fed is finally cutting
Firstly, the Federal Reserve (the Fed) is moving towards its first interest rate cut in September. The markets read the July CPI print as the final confirmation that the Fed needed and reacted accordingly. Rate cuts are economically very beneficial to all companies, even more so to companies that must borrow to invest or are not profitable yet. In other words, it tends to benefit smaller cap companies more.
- In nine out of the last 11 rate cut cycles (Starting in 1974), equities have gained in the first 12 months following the first cut.
- In six of those nine cycles, small caps outperformed large caps and mega caps.
- Also, in the two cycles when equities performed negatively, small caps beat large caps and mega caps as well, even posting positive returns in one of those two instances.
Figure 1: Historical performance in the 12 months following the first rate cut
Sources: WisdomTree and Ken French, data as of May 2024, which represents the latest date of available data. Small Caps: Low 30% portfolio. Large Caps: High 30% Portfolio. MegaCaps: high 10% portfolio. Market: all CRSP firms incorporated in the U.S. and listed on the NYSE, AMEX or NASDAQ. Historical performance is not an indication of future performance, and any investments may go down in value.
The earnings gap is closing
Secondly, the gap in earnings growth expectations between Magnificent Seven stocks and the rest of the market is closing significantly towards the end of the year. While the Magnificent Seven exhibited much higher earnings growth in 2023 and the first half of 2024, the rest of the market is catching up. Q4 2024 and 2025’s estimates are broadly similar across the two groups. This should create opportunities for stocks outside those seven mega caps to capture investors’ attention and catch up.
Figure 2: Earnings growth for US Equities
Sources: WisdomTree, FactSet. As of end of June 2024. Historical performance is not an indication of future performance, and any investments may go down in value.
The US Presidential election and an end-of-year small cap rally
Finally, the US presidential election creates significant uncertainty that tends to weigh on markets. Historically, once the election’s results are known, uncertainty lifts, which very often creates a late-year small cap rally. Figure 3 shows that, after the last 15 elections, small caps returned on average 4.77% until the end of the year, while they only returned 2.24% in non-presidential years. On average, small caps beat the market in presidential years, and mega caps underperformed.
Figure 3: Average performance of US equities in election and non election years
Sources: WisdomTree and Ken French, data as of May 2024, which represents the latest date of available data. Small Caps: Low 30% portfolio. Large Caps: High 30% Portfolio. MegaCaps: high 10% portfolio. Market: all CRSP firms incorporated in the U.S. and listed on the NYSE, AMEX or NASDAQ. Historical performance is not an indication of future performance, and any investments may go down in value.
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
