Why the S&P 500 Is Due for 5 Years of Dismal Returns Ahead

• The Magnificent Seven stocks’ dominance may soon fade, warns Glenmede Investment Management.
• Current market concentration levels mirror those of 1929 and 1999, signaling potential risks.
• The S&P 500 equal-weight index outperformed post-1999, and it could be primed to do so again.

How much longer can the Magnificent Seven stocks continue to dominate the equity market? History suggests their era of outperformance is on the verge of fading.

According to an analysis by Glenmede Investment Management, concentration levels in the top 10% of US stocks now rival levels seen in 1929 and 1999, the peaks of the two most notorious market bubbles in history.

That means trouble ahead for the largest stocks in the market — and by default, the cap-weighted S&P 500 index — warns Alex Atanasiu, a portfolio manager at the firm, which oversees $6.6 billion in assets.

Right now, the average market cap of the top 10% of US stocks relative to that of the average stock between the 30th and 70th percentiles is three standard deviations above normal levels as investors pile into AI-related stocks.

In both instances where this happened, the top 10% of stocks delivered negative returns over the following three- and five-year periods. Meanwhile, the average stock between the 30th and 70th percentiles returned 50% and 69% over those timeframes.

“It’s a tale of two markets,” Atanasiu told BI.

“We’re not saying they’re going to crash tomorrow,” he continued, referencing the top decile of stocks, “but you tend to get them either crashing and coming back or just not gaining much, but the rest of the market tends to be just fine.”

Another way of looking at how concentrated the market has become at the top is to compare the performance of the S&P 500 cap-weighted index against the S&P 500 equal-weight index. All of the constituents in the latter affect the index’s performance equally, so it can act as a better gauge of how the broader market is behaving outside of the top names.

Given the historically elevated returns from the Magnificent Seven stocks, the cap-weighted index has drastically outperformed the equal-weight index. The equal-weight index is 37% below its relative performance trend to the cap-weighted S&P 500, Atanasiu said, slightly more than 1999 levels.

In the aftermath of the 1999 lows, the equal-weight index went on a fierce five-year rally, Atanasiu said, outperforming the cap-weighted index by more than 10% per year.

Atanasiu’s outlook for relatively poor returns ahead is in line with some major Wall Street names. Goldman Sachs’ chief US equity strategist David Kostin said last year that the S&P 500 would return 3% annually through 2034, given where the Shiller CAPE ratio sits. Morgan Stanley’s chief investment officer Mike Wilson said returns would be “flat-ish” over that time. Rob Arnott, the founder of Research Affiliates, also recently told BI that he expects large-cap stocks to enter a bear market while value stocks outperform.

“It’s fascinating to note that, from March 2000 to March 2002, the S&P was down 27%, while Russell 2000 Value was up 53% (Russell 1000 Value and the full Russell 2000 were both flat, shrugging off a nasty bear market); then everything fell about 25% through end-September,” Arnott told BI in November. “When valuation gaps get wide enough, markets can utterly disconnect.”

In recent weeks, investors may have gotten a glimpse at what such a situation could look like amid the DeepSeek R1 chatbot announcement. The AI chatbot, which is cheaper to build and run than ChatGPT models, sent tech stocks tumbling in late January. Meanwhile, value factors like the Vanguard Value Index Fund ETF (VTV) remained mostly flat.

“You never had any price pressures on AI. It’s just whatever I can spend to try to get that first-mover advantage. And now you’re seeing some cost pressures,” Atanasiu said. “I think you’re going to come to grips with people’s projections for seismic earnings growth.”