Image Source: Pixabay

The ‘Magnificent Seven,’ a collective of tech giants consisting of Alphabet GOOGL, Amazon AMZN, Apple AAPL, Meta Platforms META, Microsoft MSFT, Nvidia NVDA, and Tesla TSLA, now account for 37.4% of the S&P 500’s entire market capitalisation. This means that seven stocks take up more than one-third of the total value of the 500 biggest stocks in the United States. 

While this influence has helped to drive the index higher in recent years, with the S&P 500 growing more than 80% in the three years since the launch of ChatGPT, a severe concentration risk has been emerging for investors. 

The Risks of High Concentration

One of the biggest dangers of such a high level of concentration towards just seven companies that all have exposure to artificial intelligence is that they can actively mask wider market conditions, meaning that even if most companies in the S&P 500 fall in value, the index will continue to rise just as long as the Magnificent Seven continue to drive investor interest. 

This could perpetuate a false sense of security among investors, who may invest in the S&P 500 as a diversification strategy while unwittingly leveraging an oversized level of exposure towards tech stocks. 

However, Goldman Sachs researchers have argued that high concentration in the S&P 500 isn’t necessarily a signifier of downside risk and that the index has more often rallied than declined over the 12 months following periods of peak concentration. 

This research was compiled after identifying seven episodes over the past century where the 10 largest stocks exhibited ‘extreme’ concentration, but concentration in the index is now at an all-time high, which risks skewing historical contexts. 

An Overdependence on AI

This summer, the Magnificent Seven traded at price-to-earnings (P/E) ratios of between 18 (Alphabet) and 150 (Tesla), underlining the sheer speculative nature of the S&P 500’s leading stocks and exemplifying the scale of the bet that investors are placing on the future growth of artificial intelligence. 

But can the AI boom really continue to deliver on these inflated valuations? While data has suggested that artificial intelligence could become a $1.3 trillion market by 2032, other insights warn that the adoption rates of the technology could already be slowing. 

According to a recent IBM study, CEOs have reported that just 25% of AI initiatives have met their ROI expectations in recent years, while 16% have progressed towards scaling the technology enterprise-wide. 

Elsewhere, MIT Media Lab’s NANDA Initiative has shown that 95% of generative AI pilot projects haven’t produced financial savings or noteworthy profits despite estimated corporate spending that’s upwards of $40 billion. 

Should artificial intelligence projects begin to stutter when it comes to adoption at the enterprise level, the prospective market correction from such inflated P/E ratios could be jarring for investors, even if large language models like ChatGPT and Google Gemini continue on their march into becoming everyday use technologies. 

Should Investors Be Worried? 

The Magnificent Seven have continued to secure consistent growth throughout the 21st century, long before the AI boom, and it’s likely that decision-makers will show a level of resilience even if the artificial intelligence rally begins to run out of steam. 

Despite this, the unprecedented level of concentration towards the top of the S&P 500 means that investors looking for ways to diversify their portfolios against the risk of weakening AI trends will need to look further afield. 

Rather than investing in funds that track the index, opt for more defensive stocks that are known for their resilience even as wider market contractions take place. Strong performers in challenging macroeconomic environments can include discount store stocks, as well as equities related to healthcare and energy. 

Dividend-paying stocks can also be an effective portfolio hedge to balance out an overdependence on artificial intelligence firms. 

Could the AI Boom Go Bust? 

It’s entirely possible that Wall Street’s infatuation with artificial intelligence abruptly ends due to its implementation phase failing to align with market expectations. However, it’s also important to note that the technology carries a level of transformative potential that carries fundamentals that surpass the infamous dotcom bubble at the turn of the century. 

For this reason, investors can still benefit significantly from adding Magnificent Seven stocks to their portfolio, but at a time when the AI boom is encompassing so much of the S&P 500, diversifying with more resilient stocks could go a long way in protecting against any unexpected downturns.

More By This Author:

USD/EUR Falls To Four-Year Lows As Fed Rate Cuts Loom
Li Auto’s Challenge To Tesla Could Solidify China’s Newfound Renewable Energy Pedigree
China’s Road To Becoming A Clean Energy Superpower Clears Following EU Summit And U.S. Dialbacks