"Mag 7" Leads S&P 500's Wild Ride to An All-time High Amid Valuation Concerns

The stock market experienced a shaky start in early 2022, rattled by concerns that escalating inflation would compel the Federal Reserve to hike interest rates. The Fed's subsequent monetary tightening emerged as the most aggressive in recent memory, driving Treasury yields to their highest in 16 years and taking a toll on stock values.

The S&P 500 plunged up to 25% from its zenith, bottoming out in October 2022. Nonetheless, a robust rally ensued in the latter part of 2023, buoyed by signs of significant inflation easing and the Fed's dovish stance, propelling the index upwards. The year concluded with the S&P 500 charting a 24% gain and has since made modest strides in an unsteady commencement to 2024.

The resurgence of the S&P 500 in 2023 was led predominantly by the information technology, communication services, and consumer-discretionary sectors. They also house the Magnificent Seven technology companies.

In terms of index-point contributions, Microsoft holds the top spot, adding 156.90 points. Nvidia added 141.54 points, while Apple contributed 95.40 points, with Meta and Amazon rounding out the top five.

Despite the broad market's December rally, concerns linger over the concentrated market power of the mega-cap firms. Investors in BofA Global Research's latest fund manager survey named owning the Magnificent Seven as the market's most "crowded" trade for the tenth straight month. Others said the sizeable rallies in these stocks have left them expensive compared to the rest of the market: With the "Magnificent Seven" trading at roughly 33 times expected earnings—significantly higher than the S&P 500's average of 19.6.

Furthermore, the overall forward price-to-earnings ratio of the S&P 500, now close to 20 times, exceeds its historical average, potentially posing a challenge for market expansion.

Brent Schutte, the chief investment officer at Northwestern Mutual Wealth Management Company, noted that while last year's market conditions set a low bar for positive earnings surprises, the current valuations raise the bar significantly for this year's market returns.