Top-Heavy Doesn't Mean Market Top

Key Takeaways:

• This year will likely be remembered as the year of the Magnificent Seven. While these stocks have done most of the heavy lifting for the S&P 500, it has not been a zero-sum game, as several offensive-tilted sector stocks are also beating the market this year.
• While periods of narrow leadership present concentration risk and a lack of participation from other important sectors, they have historically not been a precursor to a market top. For example, S&P 500 annual returns following its 10 most top-heavy years averaged 14.1%, with 80% of occurrences finishing in positive territory.
• Following year index returns after the 10 most top-heavy S&P 500 years have averaged 14.1%, with 80% of occurrences finishing in positive territory.
• LPL Research believes the large cap growth narrative will remain intact in 2024 and expects a continuation of offensive sector leadership.

Narrow leadership has been one of the major themes throughout 2023. The so-called Magnificent Seven mega-caps — Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla — have contributed to 60% of the S&P 500’s 26.5% total year-to-date return (as of December 27). Given this top-heavy concentration and a lack of participation from the financial sector for most of the year (the sector with the second-highest number of S&P 500 stocks), only around 29% of S&P 500 constituents are beating the index on a total return basis this year. The chart below highlights that 2023 will likely have one of the lowest percentages of stocks outperforming the market over the last 40 years.

One of the Narrowest Leadership Years in 40 Years 

Percentage of S&P 500 Outperformers by Year

Source: LPL Research, Bloomberg 12/27/23
Disclosures: Past performance is no guarantee of future results.
All indexes are unmanaged and can’t be invested in directly. 

Not a Zero-Sum Game

This year's outsized gains and contributions from the Magnificent Seven have largely overshadowed pockets of relative strength across several S&P 500 sectors. As illustrated in the table below, it is not a zero-sum game as roughly two-thirds of technology sector stocks are beating the tape this year, while around 40% of communication services, consumer discretionary, and industrial stocks are also outperforming. Collectively, these three sectors and technology represent around a 57% weighting within the S&P 500.

Percentage of Sector Stocks Outperforming This Year 

Source: LPL Research, Bloomberg 12/27/23
Disclosures: Past performance is no guarantee of future results.
All indexes are unmanaged and can’t be invested in directly. 

While 2023 will likely have one of the lowest percentages of stocks beating the market in 40 years, history suggests top-heavy years don’t translate into market tops over the following year. As illustrated in the table below, S&P 500 annual returns following its 10 most top-heavy years averaged 14.1%, with 80% of occurrences finishing in positive territory. For those expecting a small cap catch-up rally next year, we also included the following year's returns for the small cap Russell 2000 Index. While small caps outperformed the S&P 500 60% of the time over the next year, both the average and median Russell 2000 returns were underwhelming relative to the S&P 500.

Ten Most Top-Heavy S&P 500 Years

Source: LPL Research, Bloomberg 12/27/23
Disclosures: Past performance is no guarantee of future results.
All indexes are unmanaged and can’t be invested in directly. 

Summary

The narrow leadership theme of 2023 has gained a lot of attention due to the historically outsized contributions from the Magnificent Seven stocks. While periods of narrow leadership present concentration risk and a lack of participation from other important sectors, they have not historically been a precursor to a market top. In addition, there is still a sizable percentage of offensive sector stocks beating the market this year, a largely overlooked storyline. Looking ahead to 2024, LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) believes the large cap growth narrative will remain intact and is tactically overweight growth-style equities relative to value. The STAAC also expects a continuation of offensive sector leadership, including overlooked sectors like financials, as they finally start to participate in this bull market.