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It’s been well documented that the ‘Magnificent Seven’ stocks have driven much of the S&P 500’s gains this year.

They’ve also been leading the leg downward over the past month as the benchmark index just posted its worst monthly return of 2023. Some Wall Street strategists believe the losses could be healthy for the overall index.

“It wouldn’t surprise me to see a little bit more convergence,” Charles Schwab chief investment strategist Liz Ann Sonders told Yahoo Finance. “In fact I think it would be healthy for the market to have an environment like what began in early June where you started to see profit taking in that small group of stocks but at the same time you saw an improvement in breadth under the surface.”

Market breadth, meaning gains are being distributed across companies and not just from a select few names, is considered a key sign of health in the stock market. As Sonders explains, the Magnificent Seven companies are like generals leading an army. If the rest of the 493 companies, or the “soldiers,” don’t participate, the army will be inherently weaker no matter how strong the generals are.

“Even if the generals give back and step back from the front line if a bunch of soldiers are up there, it’s a stronger front,” Sonders added.

The ‘opposite’ of what was working

SoFi head of investment strategy Liz Young points out the outperformance from the Magnificent Seven hasn’t been totally abnormal. The stocks’ market caps account for about 28% of the S&P 500 index and therefore will drive gains. Large-cap stocks often out perform small-cap stocks in the late stage of the business cycle, which is where many strategists believe markets are.

The bigger question, Young argues, is when will the late cycle end?

“I think the change is underway and the leadership that has reversed since the end of July has finally put some of the relationships back into the territory that they should be, or at least headed in that direction,” she said.

Even though Young thinks the shifts could be underway, she still doesn’t see a next leg higher for the S&P 500 on the “imminent horizon.” She believes valuations for Big Tech and the S&P 500 as a whole still have further to fall before an economic slowdown “of some sort” restarts the business cycle and brings new leadership to the stock market.

Others on Wall Street agree that eventually the other 493 “soldiers” in the S&P 500 will be what leads the market higher as a cyclical trade takes over. The disagreement is around when.

While Young still sees a slowdown coming, Bank of America’s research team removed its recession call in early August. The equity strategy team led by Savita Subramanian recently boosted its year-end target for the S&P 500 to 4600, with specific conviction in the equal-weighted S&P 500 rather than the traditional cap-weighted index, which is heavily driven by the Magnificent Seven.

“We think cyclicals are the next leg where this market really could potentially reside,” Bank of America equity & quant strategist Ohsung Kwon told Yahoo Finance. “We think the macro cycle is potentially recovering and if you look at factors that have typically outperformed during this phase it’s really value, cyclicals, high beta, low quality, those beaten-down sectors have historically worked. Sectors that have historically underperformed are large-cap-growth, high-quality stocks.

“Basically it’s the complete opposite of what worked earlier this year.”

Written by: Josh Schafer @Yahoo.com

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