Does the MAG7 Really Rule the S&P 500?
I have heard people say things like:
"Without the mag 7, SPY would go nowhere" and
"Apple IS the market" and
"Tech is what the market is built on".
Various things to that effect. I have heard this more with the quite obvious AI bubble going on, where the extreme bullishness and propping of the market is being attributed to the heavily weighted mag 7 stocks, such as NVDA, META, MSFT, AAPL etc. etc.
But I wondered to myself, how true is this? And what happens when and/or if the bubble pops? What stocks are really carrying the S&P and is it true that all that matters is tech?
So, being the quant based math person I am, I decided to answer this question in the best way I knew how. Math and coding.
The questions I want to answer are:
What are the top 10 weighted stocks of the S&P?
What are the top 20 stocks over the last 5 years that have gained the most returns? Is it all tech?
What happens if the AI bubble were to pop and tech were to become a drain on the S&P?
Question #1: Is tech disproportionately weighted on the S&P?
So, let's get into the process. The first thing to do was to analyze actually how heavily tech is weighed on the S&P. This is simple enough, I can accomplish this by pulling ETF holdings from Alpha Vantage and getting their corresponding weight. Using Alpha Vantage's API, I pulled the top 10 highly weighted stocks of the S&P and here are the results:
So.. yeah, SPY heavily favours tech in terms of weighing.
Question #2: Does tech actually carry the S&P and is it the only reason the S&P sees the gains it does?
To answer this question, we need to find out, over the last 5 years, which stocks had the highest average annual return? I isolated the top 20 stocks with the highest average returns and also calculated the number of bullish vs bearish years over the 5 year period, here are the results:
You should already be seeing something interesting. While there is indeed some tech in here, there are a substantial amount of non-tech tickers. For example, NYSE:BLDR is a construction based ticker, NASDAQ:HOOD is finance, NYSE:PWR , NYSE:EME and NYSE:VST are utility based/power/electric based tickers.
You also don't see such tickers as NASDAQ:META or NASDAQ:MSFT leading the gains.
So already we have invalidated the thesis that "tech runs the market", as only 6 of these top 20 tickers are tech based, the rest vary from utilities, to finance to construction.
Another interesting thing to note is that utilities tend to be resistant to negative returns/draw downs. If you notice, NYSE:PWR , NYSE:EME , and NYSE:VST have had 0 bearish years in the past 5 years, vs the rest having some draw downs. Interesting, no?
We can't draw conclusions about the stability or returns of tech stocks from this, but we can draw conclusions about the importance of diversification. We can opine that tech sees more swings and is more prone to volatility than say stable utility based tickers. But it doesn't mean that the actual cumulative returns over 5 years wouldn't outweigh a stable stock that maybe has less returns.
So now that our findings raise this question, let's compare what our returns would be if we had bought some of these top performers 5 years ago.
Let's start with NASDAQ:NVDA
If you bought NASDAQ:NVDA October 20th, 2020, you would have bought at 13.65 per share (bearing in mind there was a split between this timeframe). Current price is 182.64, making your 5 year return 1238.46%.
Now NYSE:BLDR
If you bought NYSE:BLDR on October 20th of 2020, you would have bought it for 33.66 per share, with the current price being 122.46 being a 263.76% return on your investment.
Next NASDAQ:AVGO
If you bought AVGO on October 20th of 2020, you would have paid 37.7$ per share, with a current price of 349.24, making your return over 5 years 826.39%. Not bad.
What about NYSE:PWR
Ah, NYSE:PWR , a stable stock with 0 bearish years over the last 5 years. Had we purchased NYSE:PWR October 20th, 2020, we would currently be up 599.14%.
And what about NYSE:VST ?
Had we bought VST 5 years ago, October 20th, 2020, we would be up 912.72%. Second rank to $NVDA! Nuts right?
What about some tickers that are not on the list?
Assuming the same, you bought October 20th, 2020, here is what you would be up on various stocks:
NASDAQ:MSFT = 140.75%
NASDAQ:META = 173.65%
NASDAQ:AAPL = 123.16%
NASDAQ:NFLX = 135.73%
NASDAQ:IRDM = -34.28%
NASDAQ:GSAT = 768.78%
NYSE:VZ = -28.73%
NASDAQ:PLTR = 1858.9%
NYSE:LMT = 35.92%
NYSE:BA = 29.65%
Interesting? Probably!
In fact, this actually helps us answer our question more concretely. We can see that tech returns, while admirable, are not really all that ridiculously inflated. I mean 123% return on your investment over 5 years is pretty good, but its not 900%.
Thus, we can say that it can't be true that tech fully drives the S&P, at least not entirely.
That's all fine and dandy, but what is critical is our next question, what happens if the tech bubble (AKA AI bubble) pops? How will the weight impact the S&P?
Question #3: What happens if AI bubble pops?
Well, this is the most interesting question. And we can actually begin to answer this question, not so mathematically by simply looking at charts during the dotcom bust. We can see in 1999 at the peak of the bust, SPY lost about 50%:
Of we look at, say, NYSE:PWR and NYSE:EME during that time:
NYSE:EME lost about 36%
NYSE:PWR just over 50% but quickly rebounded while AMEX:SPY continued to tank.
So this doesn't bode well for AMEX:SPY being able to offset such a heavy weighing of tech. But let's approach this mathmatically.
Since we have the actual weight of the Mag 7.
For clarity, the Mag 7 are said to be NASDAQ:AAPL , NASDAQ:MSFT , NASDAQ:NVDA , NASDAQ:AMZN , NASDAQ:META , NASDAQ:GOOG , $TSLA.
If we take the weighing of these 7 companies and calculate the actual dollar amount this weight translates to, it translates to exactly 141.57$ USD, comprising a total weight of 31.46%.
What this means is if you were to buy $1,000 worth of SPY, approximately 315$ of your money would be allocated just to those 7 tickers, or 1,000 x 0.315 = 314.6$.
Running a simulation in R based on the weight of 31.46%, assuming that all 7 of these tickers were to drop 50%, that would equate to a loss of -15.73% on SPY. That is assuming that other companies did not, in sympathy of the bubble pop, also not come down with $SPY.
We know this to obviously be false from experience, even NYSE:PWR tanked at first during the dotcom bust and same with NYSE:EME despite them having absolutely nothing to do with dotcom nonsense.
But, in a perfect world, if only the mag7 were impacted, we would see about a -10 to -15% decline in AMEX:SPY on a bubble pop, assuming of course these companies tanked 50%.
So now what?
So I have answered my questions, I could just leave it there. But perhaps it may be more advantageous to talk about what this actually means for an investor.
We can draw some initial speculations, unfortunately we don't have enough data to draw concrete conclusions.
The first assessment we can draw is, does it even make sense to invest in AMEX:SPY ?
The 5 year return on SPY, if we bought in 2020-10-20, would be 95.5%. Had we invested in NASDAQ:AAPL or any of the other tickers I mentioned above, specifically tech, our return would have been slightly better.
It begs the quesiton, what's the point? If AMEX:SPY is so exposed to tech, its actually hindering your returns when you can just invest in the raw tech ticker itself, and diversify more fully in other tickers such as NYSE:PWR and NASDAQ:EXE to offset the drawdawns.
Overall, your returns would be better than just investing simply in the ETF SPY.
If you look at it more concretely, the R:R may theoretically be worse. If you are a savvy investor and you are up over 100% on your investment, the logical thing to do is to set a profit stop (this is something I do in my investment account). This can shield your returns from bubble pops and other financial hardship while retaining a substantial portion of profit.
You can also just chose to take profit at 100% and over and then look for something else too invest in.
When you dissect annual returns of various tickers and look at the impact these tickers have on the ETF, ETFs lose their air of "safety" and "solid investments". Because in the end, you are super exposed to a handful of stocks that you would do better to just individually invest in independently. While AMEX:SPY is diversified, being super exposed to the most volatile industries in the market does not necessarily make it a safe investment nor does it make sense from an actual R:R perspective if you were to really consider the risk that the collapse of only 7 companies of the 500 would have on the ETF itself.
This isn't advice by any means, just some food for thought.
When you dissect the anatomy of the market and its components, you can get further insight into what you are actually getting into when you buy a, quote , "safe and stable ETF" like $SPY.
These are my thoughts, opinions and some objective analysis.
Hopefully you find this information helpful and use some of these principles in gauging your risk exposure.
Thanks for reading! and as always, safe trades!
