Is The S&P 500 Outlook (Excluding The Magnificent Seven) Too Downbeat?

Authored by Simon White, Bloomberg macro strategist,

The Magnificent Seven stocks are tracking rising leading indicators, whereas the rest of the S&P 500 have decoupled from them. With NBER recession risk receding, the index excluding these tech behemoths looks too pessimistically priced.

Markets and the economy’s implied outlook for a US recession have been diverging. Yields, oil, copper and some cyclical sectors are inferring a more negative outcome than economic data.

That also applies to most stocks in the aggregate. It continues to be a two-speed market, with the bulk of recent gains driven by the seven largest stocks in the S&P 500 – Apple, Amazon.com, Microsoft, Nvidia, Meta, Alphabet and Tesla.

This was turbocharged late last year around the time OpenAI released ChatGPT 3.5.

But the remaining stocks have not thus far shared in this tech utopianism. What is interesting is the Magnificent Seven’s performance is more in line with the steady rise in US leading indicators (top panel in chart below), whereas the S&P 493, excluding these tech companies, has decoupled from them (bottom panel in chart).

So which is right, the biggest stocks, or the rest? The US leading indicator in the chart above, along with other economic data, shows that the risk of a near-term NBER recession – when stocks have historically experienced their largest drawdowns – is receding.

It is also possible the anticipated AI revolution is helping to keep financial conditions looser through supporting the broad equity index, repressing volatility (through lower implied correlations), and keeping credit spreads contained.

One of the features of this cycle has been the net loosening of financial conditions over the last year, which is a probable contributor as to why a recession has been avoided so far.

Of course, there is a risk this unravels. Benefits from AI will take time to filter through to the real economy, and a significant worsening in credit markets as they reprice to deteriorating fundamentals would set off the negative feedback loops that can rapidly result in a recession.

Until that looks like the case, though, it means the S&P 493 can start to improve as it re-couples to the more upbeat message from leading economic data.