2023 and the Magnificent 7

The stock market in 2023 had one of the most lopsided and bizarre return years on record and is likely to close out near the highs of early 2022—a two-year trip that saw a 25% drop before rallying back.

Only now is the equity market recovering from an earnings recession in which profits fell 5-10%. It could have been worse had the economy also endured a recession. An average one most likely would have clipped another 10-20% from profits.

The market’s strength has been buoyed by the Magnificent 7 (Mag7) stocks—Apple, Amazon, Microsoft, Alphabet (Google), Meta (Facebook), Tesla, and Nvidia— which drove most of the S&P 500 returns for the year.

The Mag7 began to leave the other 493 behind in March following the collapse of Silicon Valley Bank over unfounded fears of a banking-sector crisis. Small, mid-sized and foreign stocks also lagged the Mag7 throughout the year. But the massive market rally that started in late October is narrowing that performance gap, a trend that is likely to continue going forward.

If the Federal Reserve manages to orchestrate an economic soft landing of taming inflation without causing a recession, it is likely that earnings estimates are too low for the other 493, small- and mid-caps, and even foreign stocks. They currently are priced for a harder landing. Conversely, earnings expectations for the Mag7 appear to be too high.

For investors, the most prudent course of action is to stay globally diversified—in the absence of a Mag7 market mania, the performance gap between the Mag7 and everything else should narrow.