The Power of Diversification
The S&P 500 Index has posted exceptional returns for the past two quarters, but what has been driving those returns? It turns out that the most striking contributor has been the dominance of the seven largest stocks in the US: the so-called “Magnificent 7” (Amazon, Apple, Google, Meta, Microsoft, Nvidia, and Tesla). These companies alone made up 33% of the total value of the S&P 500 as of the end of March and if you were to exclude them from the index, the returns would have dropped from 10.6% to 6.0%.
In fact, over much of 2023, these few stocks were flying high and were the darlings of the market. Nvidia increased by 239%, Meta was up 194%, Tesla 102%, Amazon 81%, Google 58%, Microsoft 56%, and Apple 48%. Over this same period, the S&P 500 was up by “only” 26%. It’s at this point many investors may question the validity of a more diversified approach: why settle for 6% returns when, if you just picked the right stocks, your returns could be much higher? The simple answer is that it’s harder than you might think – you have to know which stocks to pick, you have to know when to buy them, when to sell them and you have to be willing to accept a lot more volatility once those decisions are made.
Shifting Trends
If we take a look back, most of the “Magnificent 7” incurred double-digit losses in 2022: Nvidia was down by -66%, Meta by -77%, and Amazon down -56%, just to name a few. By comparison, the S&P 500 was down “just” -25%. While they may be soaring now, just two years ago people were bailing out of those shares with seemingly no bottom in sight.
Going back a little further, all eyes were on the “FANMAG” stocks (Facebook, Amazon, Netflix, Microsoft, Apple, and Google) as they outperformed the S&P 500 throughout much of the pandemic. And now looking at this last quarter, we saw top performers like Tesla down –26% and falling out of the largest seven US stocks. All of these fluctuations illustrate how rapidly today’s darlings can turn into tomorrow’s ugly ducklings and remind us that it’s impossible to predict short-term market performance.