Why the Magnificent Seven Matters to Index Traders

Did you know that the stocks that make up the Magnificent 7 – Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia  and Tesla – account for 31% of the S&P 500 index? Or that the Mag 7’s market capitalisation is almost equal to the combined value of the Japanese, Canadian and European stock markets? A high market cap translates into a higher weightage on popular indices. This is why traders follow the performance of the Mag 7 to make informed index trading decisions.

The Magnificent 7 – An Overview

Analysts and index traders often club the most influential stocks driving market growth or decline and follow the performance of the group of stocks. This helps them identify the general trend of the stock market. The Mag 7 is the current group of the highest-performing companies on the US stock market.

The seven companies that make up this group are at the forefront of innovation in the hottest sectors, such as artificial intelligence, cloud computing, digital services, semiconductor chips and electric vehicles. Due to their high potential and global attention, these industries are critical to the global economy as well. This is why these stocks are a part of the most popular indices on the US stock market.

The performance of the Mag 7 impacts investor sentiment toward an industry segment and the stock markets in general. For instance, the S&P 500 lost 0.6% and Nvidia closed 2.1% lower in the trading session just before the AI chip giant’s earnings report was due at the end of August 2024. This was much like the declines observed when key US economic data is about to be released.

The Magnificent Seven’s Share in Popular Indices

S&P 500: 29%

Nasdaq 100: 42.3%

The Mag 7 is critical to consider for index traders because the group enjoys the highest-ever concentration by investors in the stock markets. So much so that 20% of the value of the MSCI All-Country World Index, which includes 3,000 global companies, is concentrated in the top 10 stocks. Unquestionably, the group is a part of this top layer.

A Closer Look at the Magnificent 7 Dominance

In 2023, the group grew 71% while the rest of the S&P 500 (consisting of 493 stocks) saw growth of 6%. Being market-cap-weighted, the S&P 500 experienced upside of close to 19%, thanks to the seven dominant companies.

As of September 6, 2024, the Mag 7 has added 31.33% year-to-date while the benchmark S&P 500 has risen 16.04%, Nasdaq 14.42% and DJI 30, which includes only 2 of the Mag 7 stocks, is up 8.06%. Notably, through July and early August 2024, this group of stocks drove the market pullback as well. That’s the power of dominating an index.

Year-to-date performance of the Magnificent 7, as of September 6, 2024:

Alphabet: 13.64% ↑

Amazon: 17.39% ↑

Apple: 19.79% ↑

Meta Platforms: 49.26% ↑

Microsoft: 10.12% ↑

Nvidia: 122. 57% ↑

Tesla: 7.35% ↑

Note that the DJI is a price-weighted index and not market cap weighted. That means it includes stocks with the highest share price.

What’s Driving the Mag 7’s Performance

Several factors impact the Magnificent 7. In fact, whichever group becomes the most influential in the stock market displays these characteristics:

Exceptional Adaptability

Growth-oriented companies tend to focus on research and development more to meet changing customer demands by leveraging technological advances.

Financial Health

Robust earnings, continued revenue growth and healthy balance sheets position companies to influence the financial markets.

Global Presence

Top-of-the-line companies benefit from global growth as they penetrate diverse markets. They are well-established global brands.

Market Dominance

These companies hold a major share of their respective markets due to their competitive edge.

Potential Risks of Top-Heavy Indices on Index Trading

Top-heavy benchmark indices entail certain risks that you must consider while creating an index trading strategy. These are especially critical to consider now because the S&P 500’s consolidation is at an all-time high, with the Mag 7 in the driver’s seat.

• Weighted indices are skewed heavily towards tech stocks.
• Potentially lower diversification due to higher concentration of large-cap growth stocks.
• Lower overall index yields as growth stocks pay little to no dividends. 
• Global geopolitical, regulatory and economic environments significantly impact the performance of the Mag 7 and, hence, index performance. 

Historically, higher relative index concentration results in less favourable stock outcomes, which may eventually weigh on the index in the long term. However, a shift in concentration is likely only in the event of a major macroeconomic event, such as a recession or aggressive monetary easing worldwide. There is also a risk of these companies losing growth momentum if the enthusiasm around AI cools.

Mitigating the Risks 

Index trading is a popular technique for traders to diversify their portfolios. The key to mitigating the downside risks of trading tech-heavy indices is to balance your portfolio with safe havens, such as gold and the USD. Trade indices that include small-cap and mid-cap stocks to broaden your exposure, such as the Russell 2000.  You can also look for non-correlated indices, such as the S&P GSCI Agriculture Index.

Consider Trading CFDs

Trading indices with CFDs is a popular hedging technique. CFDs empower you to explore opportunities in rising and falling markets. Since you are not trading on the price but direction and extent of price change and on leverage, CFD trading has lower fund requirements. However, margin trading amplifies both potential gains and losses. Mitigate risks associated with a position by opening smaller positions in the opposite direction and using stop loss, take profit and other risk management steps.

To Sum Up

• The Magnificent 7 is a group of companies with the highest market cap in the US.
• The Mag 7 influences all the major US indices and investor sentiment.
• Top-heavy indices pose concentration risks.
• Index traders can mitigate risks by diversifying their portfolios.
• Trading CFDs allows index traders to hedge their positions with the same index.
• Risk management is critical while trading on margin.

Disclaimer

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