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The continued outperformance of US equities—and especially the exceptional performance of the Mag 7—is raising questions among investors as to whether the rally has run its course. Two of the questions we hear most often, and that we are wrestling with as well, are:
- What to make of the high expectations priced into US equities as a whole and the Mag 7 in particular?
- What to make of the high degree of concentration of the S&P 500 today? Currently, a third of the S&P 500 is in the Magnificent Seven—and with another 12% in the rest of the technology sector, nearly half of the index is now driven by tech.
Today, I wanted to share with you some of our recent research exploring each of these questions. I hope you find it helpful.
Karen Karniol-Tambour
Co-Chief Investment Officer, Bridgewater Associates
Making Sense of the S&P 500
In terms of how we’re assessing the pricing of the S&P 500 today, the returns for any stock or group of stocks will ultimately come down to (1) how events transpire relative to what is discounted today, and (2) how the discounting of the future changes. For what is discounted today, we can look at today’s prices and earnings per share and mechanically derive what future level of EPS growth would produce a typical risk premium over bonds, if the discounted path of earnings itself does not change. That required earnings growth today is radically different for the Magnificent Seven/tech half of the market compared to the other half:
- The Magnificent Seven need to grow EPS by “only” 14% over the next decade to earn a normal risk premium over bonds—faster than the rest of the market but a lower bar than the 20% they have achieved recently. There are also big divergences within this cohort, with Tesla having significantly more optimistic pricing than the rest.
- The rest of the tech sector also needs to grow EPS by 14%, although its outlook is less clear—the sector as a whole only had 4% EPS growth over the last decade, but the legacy companies that produced that weak EPS growth have been substantially replaced by newer, faster-growing high-flyers.
- The other 55% of the S&P 500 needs to collectively grow EPS by 8% per year for the next 10 years to earn a normal risk premium—lower than the Mag 7/tech half of the market but higher than the 5% they have achieved in the past. This group is itself very diverse, but most subcomponents would need EPS growth similar to or better than the last 10 years to generate a normal risk premium.
Below, we summarize this pricing on a single chart. The blue bars show the last decade of realized EPS growth for the Mag 7, the tech sector ex-Mag 7, and the rest of the S&P, while the red bars show what future EPS growth would be required to earn a normal risk premium.
As you can see, while the Mag 7’s valuations are high in absolute terms (double-digit discounted EPS growth to earn a normal risk premium), this is actually lower than what we think a fair price would be if they continue growing earnings at 20%. And for the rest of the S&P 500, while in isolation their valuations may appear “cheap,” in actuality one would need to believe their growth will accelerate to justify paying current prices.
In terms of how we’re assessing the concentration of the S&P 500 today in the Mag 7, while it is unusual to have this much concentration in the top seven names, it is not unprecedented. As the chart below on the left shows, this level of concentration among the top seven companies was last seen in the 1950s and 1960s, when the largest companies included AT&T, General Motors, and DuPont. This was actually a strong period for US equity returns, both for the mega-caps of the time as well as more broadly. Historically, there has also been no sustained outperformance or underperformance for the largest seven companies versus the rest of the S&P 500. The chart on the right shows the rolling 10-year return of owning just the seven largest companies versus the entire S&P 500—over time the returns are similar.
While concentration is not inherently a bullish or bearish signal from a tactical perspective, it still creates strategic risks for investor portfolios. The concentration of many investors in US equities, especially combined with US equities’ concentration in AI, creates significant portfolio diversification challenges. Events like the DeepSeek sell-off highlight how oversized exposure to a small number of similar companies increases vulnerability to idiosyncratic market moves.
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