By Andrew Graham

Earlier this month, the Philadelphia Eagles won the Super Bowl in a blowout, delivering a dose of reality to the Kansas City Chiefs, who before then could seemingly do nothing wrong. The question going into the game wasn't just whether the Chiefs were among the greatest teams in NFL history. It was, 'Is this one of the best teams in the history of American professional sports?'

That chatter has naturally died down since. Here's something new to think about: Could the Magnificent Seven experience a Chiefs-like trajectory this year? In other words, the group may still be great but perhaps not as great as in the past. If so, it could have more of an impact on everyday investors than most appreciate.

Lower earnings growth for mega-tech. According to consensus estimates, Magnificent Seven earnings growth will slow meaningfully this year, with forecasts calling for an 18% bump. That's obviously still good, but it's well off the gain of 33% in 2024.

Notably, earnings growth for the rest of the S&P 500 (i.e., the other 493) are slated to jump in 2025, from 3% to 12%. The result would be a 6% gap between the two, the slimmest margin in seven years.

It's important to note that this sort of convergence is a net positive for equities. It signals that breadth is widening following two years when the Magnificent Seven has been responsible for over half of the S&P 500's gains. Yet, if that does happen, it could create frustration for some investors.

Market concentration. Since the pandemic, many investors have piled into the Magnificent Seven, buying any dips along the way. Up to this point, they have likely been rewarded. Other investors are less willing to expose themselves to that type of concentration risk, choosing instead to diversify, with some opting for ETFs or mutual funds that track the S&P 500.

Of course, this approach has also done well. After all, the S&P 500 has averaged double-digit returns for over a decade. However, the issue is that many of those funds have more exposure to the Magnificent Seven than most investors appreciate.

For example, the Magnificent Seven group now makes up 32% of the SPDR S&P 500 ETF Trust $(SPY)$. The issue is more acute for the Invesco QQQ Trust $(QQQ)$, which seeks to mimic the Nasdaq 100. It is 44% weighted in Magnificent Seven names. Cumulatively, those funds have almost $1 trillion in assets under management.

Performance could lag. Clearly, this phenomenon doesn't spell doom. Even if Magnificent Seven earnings growth drops off to 18% as projected, investors in popular index funds like those mentioned above should continue to benefit. But how much they stand to benefit becomes less certain when you consider that this year's earnings forecasts are already factored into stock prices.

Even so, you could ask, 'What's the big deal? Funds will adjust their holdings to reflect market convergence, right?' They do. But that process can take time -- too much time in some instances. That's why equal-weighted funds could be more attractive as money slowly rotates away from Magnificent Seven stocks over the next several quarters.

Equal-weighted funds. These funds are exactly what their name suggests: rather than trying to reflect the makeup of the S&P 500 based on each company's size, they treat each component equally. Apple $(AAPL)$ and its more than $3 trillion market cap counts the same as Amentum Holdings $(AMTM)$, which is a fraction of the size.

The appeal of equal-weight S&P 500 ETFs was highlighted during the week when DeepSeek shook the markets. Invesco's equal-weighted S&P 500 ETF $(RSP)$ outperformed the S&P 500 by nearly a percentage point over those five days. So far this year, the Magnificent Seven is up about 2% while the rest of the S&P 500 (both SPY and RSP) has advanced 4%, suggesting that we could continue to see similar disparities over the longer term.

To be sure, even though the Chiefs got battered in the Super Bowl, they could come back and win another one next season. Similarly, any bumps in the road the Magnificent Seven encounter this year could be temporary. But make no mistake, those bumps would impact investor portfolios more than most realize. Indeed, investment themes can endure, but over time, there are no sure bets, including the Magnificent Seven.

Andrew Graham is the founder and managing partner of Jackson Square, a San Francisco-based RIA. A 40-year veteran of the industry and Chartered Financial Analyst, he serves as the firm's portfolio manager.

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

February 18, 2025 15:45 ET (20:45 GMT)

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