S&P 500 (^GSPC 2.53%) It’s up 80% since 2019, and most of that rise has come from a relatively small number of stocks. Apple And Nvidia alone contributed a quarter of the gains, and The Magnificent Seven accounted for half. As a result, the S&P 500 has become increasingly concentrated. In fact, the top 10 companies now account for 36% of market capitalization, something that has never happened before.

Some experts expect the situation to end in disaster. Goldman Sachs analysts predict the S&P 500 will return just 3% annually over the next decade due to concentration and rising valuations. This is in sharp contrast to the long-term average of 11%. But other analysts are less concerned because of the Magnificent Seven’s fundamental strength, and history suggests concentration can be a good thing.

S&P 500 index is behind S&P 500 Equal Weight The index is up 8 percentage points this year, largely due to strength in the most heavily weighted stocks. That’s important because the S&P 500 has outperformed its equally-weighted rival by at least 5 percentage points only six times over the past 50 years, often followed by strong gains in the following year.

The S&P 500 is doing something it’s only done 6 times in the last half century

S&P 500 It tracks the performance of 500 major U.S. companies, covering nearly 80% of domestic stocks by market capitalization. Because of its coverage, the index is generally considered the best barometer of the U.S. stock market.

Since 1971 the S&P 500 has outperformed the S&P 500 Equal Weight index (EWI) — which includes the same companies but with the same weights — by at least 5 percentage points only six times: 1990, 1995, 1998, 1999, 2020 and 2023. The chart below shows the S&P 500’s return this year and next year.

Data source: YCharts. All percentages have been rounded to the nearest whole number. An asterisk indicates that the 2024 full-year return is not final and is subject to change.

As shown above, the S&P 500 returned an average of 17% over the following 12 months, during which the index outperformed its equally weighted counterpart by at least 5 percentage points.

So what? Assuming the S&P 500 is at least 5 percentage points ahead of the S&P 500 EWI by the end of 2024, history says the index will return to 17% in 2025. Of course, past results are never a guarantee of future performance, but that’s another reason to expect strong returns for the S&P 500 next year.

Federal Reserve recently cut benchmark interest rate It’s the first time since 2020, and analysts expect rates to continue falling in the coming year. According to global investment strategist Sarah Stillpass, “Five of the 10 best years for the S&P 500 since 1980 occurred when the Fed cut interest rates.” JPMorgan Chase.

Stock market concentration and rising valuations pose risks to investors

The S&P 500’s performance is largely driven by a handful of companies. This concentration is certainly risky, but in this case it is not necessarily a bad thing. Magnificent Seven They are some of the most fundamentally sound companies in the world. They achieved aggregation profit margin It had a profit margin of 23.5% in the June quarter, according to JPMorgan, while the other 493 companies in the S&P 500 had profit margins of 8.5%.

What’s more, the Magnificent Seven companies are growing earnings faster than the rest of the index, and Wall Street analysts generally expect this pattern to continue next year, as detailed below:

• 2023: The Magnificent Seven reported a 31% increase in earnings, while the other 493 S&P 500 companies reported a 4% decrease in earnings.
• 2024: The Magnificent Seven is projected to report earnings growth of 36%, compared to 3% for the other 493 companies in the S&P 500.
• 2025: The Magnificent Seven is forecast to report earnings growth of 18%, compared to the 14% profit growth of the other 493 companies in the S&P 500.

Investors should be aware that stock market valuations are rising. S&P 500 is trading at 26.7 time gainThis is a significant premium compared to the 10-year average of 21.8 times earnings. Meanwhile, most of the Magnificent Seven have even higher coefficients; so much so that the average valuation across the group is 42.5 times earnings.

The big picture is this: A few mega-cap companies carry the S&P 500, but history says the index could return 17% next year as the heaviest members gain strength. However, since many stocks are historically expensive, any blows your way, whether it’s weak earnings results or worrying macroeconomic data, could send the S&P 500 into a correction or bear market. Investors should hope for the best but mentally prepare for the worst.