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Market Commentary: July 2023 – Take a Breadth

Take a Breadth

July 2023

By Robert F. Taylor, CFA

Imagine yourself strolling down a vibrant city street filled with bustling shops and lively businesses on both sides. The atmosphere is electrified with excitement and endless possibilities as people explore the diverse stores, each catering to different tastes and desires. From trendy boutiques to niche specialty shops, the options seem limitless. This vivid scene serves as an analogy for a market with great breadth, where there is something to satisfy everyone’s needs.

Now, let’s transport ourselves to a different street, one that feels strangely constrained and limited. Here, only a handful of shops monopolize the entire stretch. As you walk, you quickly realize that your choices are severely restricted. You’re forced to browse the same repetitive stores, yearning for variety and desperately searching for something special. The street feels stagnant and uninspiring, leaving you longing for more options and the excitement of discovering something new.

This analogy of contrasting streets can be applied to the stock market, where breadth plays a similar role. In this context, the shops represent stocks and sectors. A market with wide breadth resembles the bustling city street, featuring a diverse array of companies, industries, and sectors thriving side by side. Just like the vibrant street, this healthy market environment offers investors countless opportunities to find investments that align with their unique goals and preferences. On the other hand, a market with narrow breadth or concentration resembles that confined street, where only a select few stocks dominate the landscape.

In the first half of 2023, the equity market has shown remarkable resilience. As of June 30th, the S&P 500 Index delivered a total return of 16.9%, while the Nasdaq 100 boasted an even more impressive return of 39.4%. These returns are particularly noteworthy considering the ongoing monetary tightening by the Federal Reserve, rising bond yields, multiple bank failures, sluggish corporate profits, and persistent economic uncertainty.

To investors solely focused on returns, it may appear that the entire stock market is performing well. However, upon closer examination, it becomes evident that the market breadth is narrow, and only a handful of mega-capitalization stocks are responsible for the majority of the market’s gains in 2023. Collectively, Apple, Microsoft, Nvidia, Amazon, Meta Platforms, Tesla, and Alphabet – referred to as the Magnificent Seven (Footnote 1) – have contributed 1,230 basis points* to the S&P 500’s 16.9% year-to-date return. Said differently, the Magnificent Seven’s YTD returns make up about 73% of the S&P 500 Index’s YTD return (12.3% of 16.9%). Taking this a step further, the five largest S&P 500 stocks by market capitalization (AAPL, MSFT, GOOGL, AMZN, NVDA) have contributed a remarkable 994 basis points, accounting for 59% of the S&P 500’s 16.9% return. To put this in perspective, historical data (Footnote 2) show that in years when the S&P 500 has risen, the five largest stocks typically contribute only 3% of the returns, with the top ten stocks contributing just 5%.

* A basis point is equal to 1/100th of a percentage point. Thus, 100 basis points is equivalent to 1.00%.



When considering market capitalization, the Magnificent Seven now represent approximately 27% (up from 20% at the beginning of the year) of the S&P 500, an index that assigns weights based on the market value of included companies. Despite these seven stocks constituting over a quarter of the index, the S&P 500 remains well-diversified from a regulatory standpoint, which is crucial considering the $2 trillion in mutual fund assets benchmarked to the index. According to the Investment Company Act of 1940, a “diversified” fund or index cannot hold more than 25% of its portfolio in positions that individually account for more than 5% of the portfolio. As of July 17th, only Apple at 7.5% and Microsoft at 6.8% exceed the 5% weight limit in the S&P 500.

However, the Nasdaq 100 (NDX) index is currently experiencing significant concentration, leading to the announcement of a special rebalance to address this concern. The Magnificent Seven currently account for a weight exceeding 56% of the total index. With the upcoming special rebalance scheduled for Monday, July 24th, the weight of these seven stocks will be reduced to 44%. It’s important to note that even after the rebalance, the NDX will still retain a level of concentration that falls short of meeting the SEC’s criteria for being classified as a “diversified” index.

While we expect some selling pressure on the seven stocks during the rebalance day (along with buying pressure on others increasing in weight), we do not anticipate significant impact on our portfolios resulting from the special rebalance. In fact, Goldman Sachs found that during a previous special rebalance in 2011, there was minimal performance impact on the stocks involved. We believe that factors including earnings growth, valuation, and the macroeconomic environment will be the primary drivers of returns for our portfolios over the next six to 12 months.

1. Credit to YCharts for coining the term “The Magnificent Seven”

2. Morningstar: 5 Charts On the Super Concentrated Stock Market

Shannon Dermody

Shannon DermodyTEST

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