Animal Spirits Or Anxiety?
Big Tech and the strength of the Magnificent 7 stocks have powered the S&P 500® to 36 all-time closing highs through the end of October. Amid the euphoria, nervousness about the AI boom1 has sent jitters through the market, most recently with SoftBank’s sale of its stake in Nvidia.
The extreme level of mega-cap dominance is reflected through the S&P 500 Equal Weight Index, whose trailing 12-month underperformance versus the S&P 500 plunged to 13% as of Oct. 31, 2025, with even worse levels seen in 1999 prior to the bursting of the tech bubble. With bubble fears in the air, it might be helpful to travel back to the past to understand the challenges of stock selection, especially throughout turbulent market regimes, with the knowledge that only a handful of stocks have outperformed over the long term.
Imagine it is Dec. 31, 1999. You are a professional portfolio manager and have witnessed five consecutive years of double-digit gains for the S&P 500, with a cumulative return of 253%. You are a bit apprehensive about whether these gains can continue and decide to seek five stock recommendations from your favorite Wall Street forecasters, denoted as Stocks 1-5,2 which you carefully consider.
Luckily for you, a genie appears to grant you one wish. You decide to ask which of the five stocks will be the best performer in the future. Unfortunately, our genie lacks expertise in one important respect: she knows a good bit about volatility but less about the returns of individual stocks.
The genie first reveals the future volatility of each stock, measured simply by the annualized standard deviation of daily returns. Exhibit 1 shows that all five stocks will be more volatile than the S&P 500, with standard deviations ranging from 59% (Stock 1) to 26% (Stock 5).
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You’re a bit nervous about the high volatility of the first stock, but Stock 5, while still more volatile than The 500™, looks relatively more benign. The genie next tells you about the frequency of large losses in Exhibit 2, which shows the probability of the stocks declining by at least 1% or at least 5% on a single day. Stock 1 is the most likely of the group to have large daily losses, which has increased your anxiety.
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It is now Nov. 13, 2025, and it’s time to evaluate how well each of the forecasters did and how well you would have done to have taken their advice. Exhibit 3 tells us the actual identity of the five stocks and their total return since Dec. 31, 1999. Stock 1, Nvidia, was the best performer in our study,3 with a stunning cumulative performance of more than 200,000%, followed by Apple, Amazon and Microsoft. Stock 5, Exxon, although the least volatile, underperformed The 500.4
On a risk dimension, the best performer was the most volatile holding. Volatility tests an investor’s conviction, and sometimes the stocks you will have most wanted to own are the hardest to hold. This psychological difficulty is exacerbated for professional asset managers, who, acting as fiduciaries for their clients, may face challenges convincing them to stay confident when the market moves against their favor.
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Going back to Dec. 31, 1999, you would not have known that tough times were soon in order, with the S&P 500 about to post declines for the next three consecutive years, followed later by the Global Financial Crisis of 2008. Much later would be the COVID-19-related downturn in 2020, the losses in 2022 and most recently the tariff-related tumult in early April 2025. Over long horizons, most stocks underperformed the market,5 and we know that most active managers underperformed with them, perhaps because historically, holding onto volatile stocks through painful periods of underperformance has required courage when one’s natural instinct is to sell.
2 The stocks recommended can, but do not have to be a member of the S&P 500 at the time of this exercise.
3 The prescience of the forecaster who recommended Stock 1 is admirable, but we know that stock market forecasting is notoriously difficult, as any reader of our SPIVA® Scorecards will recognize.
4 Nvidia and Amazon joined the S&P 500 in November 2001 and November 2005, respectively.
5 Bessembinder, Hendrik. “Which U.S. Stocks Generated the Highest Long-Term Returns,” Nov. 11, 2024.
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The posts on this blog are opinions, not advice. Please read our Disclaimers.
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