Apr 19, 2024

The Magnificent One

Apr 19, 2024
Mark R. Gordon — JD, MPP, CFP®, CFA
Chief Investment Officer
The first quarter treated equity investors well. Globally, stocks rose more than 8% over the past three months.1 Domestic stocks led the way, with the S&P 500 up about 10.5%. Developed, foreign stocks went up nearly 6% and emerging-markets equities ticked up under 2.5%.2 The US bond market dropped a bit, just under 1%.3

In Q1, large, growth companies continued their relative dominance. In the US, growth companies returned roughly 11.5% and value companies “only” returned 9%.4 We say “only” to help put things in perspective: these are quarterly returns. Value stocks had an annualized return of over 40% for the quarter!

Another trend continued: a handful of very large, mostly tech companies accounted for more than half of the return of the S&P 500, a common proxy for the US market. The so-called “Magnificent Seven” stocks (Amazon, Apple, Google, Meta, Microsoft, Nvidia, and Tesla) had an average return of 17%, more than doubling the return of the (to coin a phrase) “Less-Than-Magnificent 493.”5 Given the relative returns, and the financial media’s focus on these seven companies, we’d like to take a closer look at them.

As a group, the Magnificent Seven saw 17% returns for the quarter, significantly higher than the 10.5% index return. Now let’s take a closer look: The chart below shows the Magnificent Seven, ranked from highest to lowest Q1 return. It also shows the weight of each company in the S&P 500:

Magnificent 7 Stocks

The third column shows how much each company contributed to the return of the S&P 500 index for the quarter. Nvidia, for example, had a blockbuster return of 82.5% in Q1. At the beginning of the quarter, Nvidia represented just over 5% of the index. By multiplying the two, we get (5.1% x 82.5%) = 4.1%, meaning Nvidia alone contributed over 4% of the index return. The S&P 500’s total return for the quarter was 10.5%. Thus, Nvidia was responsible for (4.1% / 10.5%) = nearly 40% of the index return!

Several more details jump out from this chart. First, the Magnificent Seven weren’t all so magnificent. Four companies provided returns above the index and three had returns below it. Moreover, the spread was enormous. As noted above, Nvidia nearly doubled during the quarter, but Tesla lost nearly one-third of its value. We think it’s fair to say that, despite the media attention and catchy name, this group of companies is hardly a monolith.

In fact, Nvidia is such a highflyer that it is threatening to outpace the rest of the Magnificent Seven the same way the Magnificent Seven have outpaced the rest of the S&P 500.6 That’s why today we’re calling Nvidia, with tongue in cheek, the “Magnificent One.” If all you need to beat the index is the Magnificent Seven, and all you need to beat the Magnificent Seven is Nvidia, why would anyone own anything else other than Nvidia?

It’s a rhetorical question, but we’ll answer it. No one would describe a one-stock portfolio as prudent. If Nvidia continues its meteoric rise, single-stock investors will be able to retire quite early. However, if something unexpected happens, it could mean financial disaster. But how often does something very bad happen to a highflyer?

Let’s examine Tesla, one of the Magnificent Seven. The electric car maker’s price exploded beginning in 2013. From 2013 through the end of 2019 the stock price rose 1,140%, more than 40% annually.7 In 2020, Tesla capped its remarkable run with a calendar-year return of 743%. Over this time, Tesla grew so much it became one of the largest companies in the world. On December 21, 2020, Tesla was added to the S&P 500 index. The chart below shows Tesla’s returns from the start of 2013 through its inclusion in the S&P 500:

After eight years of eye-popping returns, many investors considered Tesla to be a “no brainer” way to beat the index. Indeed, based on the trailing returns, Tesla made the S&P 500 look like a literal flatliner.

Let’s now look at Tesla’s returns since it joined the S&P 500 through Q1 2024:

During this time, the S&P 500 rose 50%, more than 13% annualized. Tesla, unfortunately, lost nearly 20% of its value. This is why we believe highly concentrated portfolios are closer to gambling than investing. If the market is up 50% and your portfolio is down 20%, that’s a huge shortfall that may take a decade or more from which to recover. Most of us aren’t interested in working an extra 10 years if we guess wrong on a concentrated portfolio.

But is Tesla an anomaly? No. In fact, as we can see in this chart, after companies become one of the 10 largest in the country, they tend to underperform the broad market. The average underperformance isn’t as stark as Tesla’s, but history shows that chasing returns often leads to disappointment.

Investors shouldn’t be surprised by this phenomenon. Typically, when companies rise among the world’s largest, expectations are at all-time highs. The higher our expectations, the greater the chance of an unpleasant surprise. Even great companies can struggle to meet sky-high investor demands. When that happens, investors ratchet down their predictions. Other things equal, that means lower returns for previous winners.

We often say, “The downside of diversification is that it works.” When we diversify, we know we will own some winners and some losers. But that means, looking back, we can always identify some stocks that, had we owned only them, we would have done better. We believe that’s what can lead investors down a matryoshka-doll system of increasingly concentrated positions.

We believe our portfolios should help us meet our financial-life goals, not maximize short-term gains. In our experience and opinion, a diversified portfolio is the best way to build a wealthier life. The more we diversify, the more confident we are that we will achieve market returns and our long-term goals. We may not always have the latest investment fad, but that’s precisely the point.

[1] Global stocks represented by the MSCI ACWI Index (net). All investment returns from Morningstar unless otherwise noted. Past performance is no guarantee of future results.

[2] Developed-markets stocks represented by the MSCI EAFE Index (net). Emerging-markets stocks represented by the MSCI Emerging Markets Index (net).

[3] US bonds represented by the Bloomberg US Aggregate Bond Index.

[4] Growth stocks represented by the Russell 1000 Growth Index. Value stocks represented by the Russell 1000 Value Index.

[5] Source: Morningstar and Wealth Architects.

[6] Thomas, 2023 Review – Magnificent Seven Lead Domestic Large Cap Outperformance, Forbes.com, January 24, 2024.

[7] All Tesla returns data from YCharts.com unless otherwise noted.

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