The US stock market is on edge. The S&P 500’s recent 10% correction has investors worried, though a highly uncertain policy environment and an unusually top-heavy market obscure just what is spooking stocks.
Two pain points come to mind, one in plain sight and the other harder to see. The obvious one is the barrage of pronouncements from the White House, some of which affect companies directly, most notably trade policy. The business environment has become so tense, in fact, that even typically apolitical corporate executives are starting to grumble about the administration’s economic agenda.
The other vulnerability is the S&P 500’s big bet on the Magnificent Seven, the technology behemoths that account for nearly a third of the index. Just as their astounding growth boosted the market for years, a slowdown would be a drag.
The two threats are likely to manifest differently, however. A trade war should disproportionately hurt sectors targeted by tariffs such as energy, industrials, materials and consumer products. A slowdown in Big Tech, on the other hand, should directly strike the Magnificent Seven — Apple Inc., Microsoft Corp., Nvidia Corp., Amazon.com Inc., Alphabet Inc., Meta Platforms Inc. and Tesla Inc.
Now consider what happened during the market’s recent selloff: Every one of the Magnificent Seven was down, with a median decline of 14.4%. The group’s losses were responsible for nearly half of the S&P 500’s total decline. The rest of the S&P 500, by contrast, fared better. About a quarter of the index’s stocks posted gains during the period, with a median decline of 6.6% when excluding the Magnificent Seven.
Nor did the selling target companies exclusively or even mostly in the path of tariffs. Industrial and consumer companies, for example, were well represented among the winners, including automaker Ford Motor Co. and grocer Kroger Co. Meanwhile, the technology sector, which is among the sectors best insulated from tariffs, took a drubbing. VeriSign Inc. was the only tech stock that advanced during the period.
So, on a closer look, the selloff seems more like a reckoning with the future of Big Tech than a freakout over tariffs. It’s hard to see that looking only at the S&P 500’s headline decline, mainly because much of the result is driven by seven stocks that obscure the rest of the field, particularly the index’s smallest 200 to 300 stocks by market value.
The apparent focus on Big Tech may be part of a larger recognition that the economy is slowing and inflation remains stubbornly above the Federal Reserve’s 2% target, as Chair Jerome Powell acknowledged on Wednesday. Bond markets have been warning about those headwinds for some time, with two- and 10-year Treasury yields declining in recent weeks and the five-year breakeven rate — the difference between nominal and inflation-adjusted yields — remaining near 2.5% from closer to 2% in September.
It’s not that Big Tech is uniquely vulnerable to a slowdown in the economy — on the contrary, its hefty size gives it more insulation. But the Magnificent Seven have grown at astonishingly high rates for years. A mere downshift to more normal growth rates would still be a significant retreat.
It would also be bad news for the mighty S&P 500 — and probably more consequential than anything happening in Washington, DC. That’s because Big Tech has fueled most of the market’s gains for at least a decade. The Bloomberg Magnificent Seven Index is up 36% a year from June 2015 through February, excluding dividends, many multiples of the market’s long-term price return of closer to 6% a year since 1928. Remove the Magnificent Seven from the S&P 500 and its price return drops to an unremarkable 5% a year since 2015.
Importantly, the Magnificent Seven’s surge can’t be attributed to a speculative mania like the one that fueled internet stocks in the 1990s or the so-called Nifty Fifty in the 1960s by stretching their valuations. Instead, Big Tech’s success stems from one of the most spectacular bursts of earnings growth ever recorded. Earnings per share for the Magnificent Seven index grew by 37% a year since 2015, more than five times the annualized earnings growth of the S&P 500 since the 1950s. The rest of the field were no slouches — they grew earnings by 8% a year collectively over the same time, but they were overshadowed by Big Tech’s freakish growth.
Given that earnings growth rather than changes in valuation pushed shares of the Magnificent Seven higher, it’s reasonable to assume that earnings are also behind the recent declines, only this time driven by lower expected growth. That reading is supported by the group’s valuations, which are not cheap but, except for Tesla, also not hysterical. Alphabet trades at 17 times forward 12-month earnings, Meta trades at 22 times and the others trade in the mid-20s. That’s not much higher than the rest of the S&P 500, which trades at around 20 times as a group.
If the market continues to focus on the Magnificent Seven, the S&P 500 could experience further declines even as many stocks in the index move higher. In that event, the index’s declines could coincide with developments in the nation’s capitol but have little to do with them.
The opposite could also be true. If a trade war intensifies, smaller companies with less pricing power to pass on higher costs to consumers may take the brunt while Big Tech skates by. This time, the S&P 500 may seem tranquil even as many businesses suffer.
One thing is for sure: A broad market dominated by seven stocks is a poor gauge of what ails stocks.
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