US equity opportunities beyond the Magnificent Seven

Preview

The outlook for US equities in 2024 has a rare complicating factor—the high concentration at the top of the S&P 500 Index, where the largest seven stocks represent more than 25% of the index by market capitalization. Lifted by investor enthusiasm for the potential of generative artificial intelligence (AI), these “Magnificent Seven” stocks led performance in a market otherwise weighed down by concerns about recession and tighter financial conditions as the Federal Reserve (Fed) worked to bring down inflation.

To gain insight on what this concentration might mean, we consider a period with similarities to today—the end of the dot-com era in 2000 and 2001. At that time, optimism for the growth potential of the internet resulted in a similar concentration at the top of the S&P 500. Gross domestic product (GDP) growth was beginning to decelerate, and the Fed was preparing to reduce interest rates.

At Franklin Templeton Institute, we expect similar conditions in 2024, with the global economy likely to slow and central banks likely to cut rates. We believe market leadership might shift to areas of undervalued earnings power outside the Magnificent Seven, including both megacaps as well as small caps that offer sustainable earnings quality.

Key takeaways

• High earnings expectations combined with a slowing economy may make the stock market prone to disappointments in 2024.
• The “dot-com” period, which featured similar index concentration and falling interest rates, offers clues to trends this year.
• We see attractive potential in areas that would allow investors to diversify their US equity portfolios beyond the Magnificent Seven.
• The fundamental characteristics across the largest companies, imply superior earnings power than in the past, with valuations more attractive for those outside the Magnificent Seven.
• Smaller companies exhibit particular characteristics that make them more attractive in today’s environment.