After years of the market being led by US mega-cap companies, such as Apple, Microsoft, Nvidia and Tesla, and a steady procession of articles fating an era of continued US stock market exceptionalism – came a shock. Stocks go up, but can also go down.
We have previously written about the phenomenon of the ‘Magnificent Seven’ – a small number of large, US tech companies driving the market forward through their own stellar outperformance. That the S&P 500 has had a phenomenal run is undisputed – since 1st March 2009 to 1st March 2025, from the approximate lows of the global financial crisis to today, the average annual return of the S&P 500 has been 15.5%. This dwarfs the returns from the FTSE 100, Euro Stoxx and Japan’s TOPIX indices, which have all annualised in the region of 9-10% over the same period.
Whilst the recent underperformance of the Magnificent Seven stocks has led to some near-term declines in share prices, these could be a mere bump in the road (or not), compared to some of the longer-term risks being built up for passive strategies.
The relative underperformance of active managers and a focus on driving down fund costs, has helped move increasing numbers towards a passive-investment strategy – accepting that tracking an index will deliver an acceptable investment return over time, whilst containing costs, rather than looking at active options – which are both more expensive and have no guarantee of outperformance. According to Morningstar Direct, an investment research firm, US long-term assets invested in passive strategies rose from just over 20% in 2008, surpassed 50% in 2023, and increased to 53% by the end of 2024. Consistent strides also continue to be made globally too as assets in passive strategies chip away at the waning dominance of their active peers.
The good news is that, since the financial crisis, this has worked! Whilst US equity market strength since the global financial crisis (GFC, 2007-2009) has been one to behold, high starting valuations and investor expectations today, need to come with the realistic expectation of more contained returns going forward in US equities. Part of the very reason why returns since the financial crisis have been so strong is because valuations were so attractive at their lows in the GFC. In recent years, they have also been super-charged by stellar earnings from the Magnificent Seven, as well as the strength of the US dollar being the cherry on the cake for unhedged UK investors. As we wrote in Whoa, we’re halfway there! market cycles exist and there’s rarely a permanent winner to follow over decades and decades.
“There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”
J K Galbraith, Harvard Professor, Economist, Presidential Adviser
The below chart, courtesy of JPM Asset Management, highlights how over recent decades the global equity market has concentrated geographically.
Source: JPM Asset Management, Guide to the Markets US, 31/01/2025
Likewise, within the US market itself, it has got more concentrated and expensive too. The largest seven companies now represent approximately 33% of the total market cap of the index, which is roughly double what it was just five years ago. Similar, but not to the same extent, US assets also form an increasing amount of fixed income markets for passive investors to follow.
If you’ll forgive me for taking J K Galbraith at his word and looking at past performance, the above chart also shows the peaking of the Japanese equity market back in the late 1980’s, when at the close of 1989 Japanese equities both peaked and were dominating global equity indices. Meanwhile, the below chart shows the returns from the S&P 500 and Japan’s TOPIX since then. Food for thought perhaps?
