The “Magnificent 7” stocks are likely to continue falling out of favor as investors turn to cyclical stocks that benefit from economic growth.
Investors’ worries about tariffs and tech company spending continue to dominate recent headlines. Against this backdrop, the S&P 500 Index has traded in a relatively narrow range, currently back to about where it was in early December, while volatility continues to pressure the bond market.
Many investors, likely distracted by the torrent of news coming out of Washington, might conclude this is just another seasonal first-quarter lull for markets. But under the surface, Morgan Stanley’s Global Investment Committee sees a continuing shift, with the long-dominant “Magnificent 7” mega-cap technology stocks likely to continue falling out of favor as investors move money toward “cyclical” stocks that are sensitive to economic growth. This pivot comes as a wider variety of stocks within the S&P 500 are gaining, even as the Magnificent 7, which have powered much of the index’s recent advance and account for an outsized share of its overall value, have recently struggled.
Consider three developments supporting this continued “rotation” in stock market leadership.
1. Some sectors are beginning to show the lagged effects of monetary-policy easing.
Recall that the Federal Reserve cut its benchmark rate by a full percentage point in the fourth quarter of 2024 before pausing on further cuts. Now, this move is beginning to stimulate parts of the economy, which is settling into a “soft landing” of slower-but-steady growth and cooling inflation. For example, the Institute for Supply Management’s manufacturing indices returned to expansion in January, driven by a surge in new orders, after a long run in contraction territory. Hiring in manufacturing also appeared to pick up, while a survey of loan officers suggested a solid increase in bank lending availability.
2. Large companies’ earnings growth is slowing.
Overall, S&P 500 companies are expected to post an 8.5% year-over-year increase in profits for 2024. However, below the surface, the biggest 100 companies in the index are beating Wall Street’s forecasts at much lower rates than the next 400. What’s more, these larger companies are trading down 50 basis points, on average, the day after reporting results. Investors’ anxiety is particularly palpable around the Magnificent 7, whose earnings growth is poised to slow this year as profitability gains steam for the rest of the index companies. Forecasts for 2025 now see S&P 500 earnings of $274 per share, down from previous estimates of $282.
3. Large tech stocks are struggling while other sectors and asset classes pull ahead.
Consider that the typically high-performing S&P 500 technology sector lagged the broader index in January by the widest margin since 2016. Four of the Magnificent 7 have recently been trading below their 50-day moving averages, another bearish signal for traders. In addition, hedge funds are increasingly reducing gross exposures to these kinds of stocks for the first time in a year, while company insiders are selling shares at the highest rate since 2021, raising questions about the companies’ ability to achieve earnings targets and justify their lofty valuations. Meanwhile, look at the investments that are currently leading the markets: financials and healthcare, as well as mid-cap growth-oriented equities, European stocks and gold.
Portfolio Consideration
In this environment, the Global Investment Committee believes investors should consider adding exposure to cyclical stocks like financials, energy, domestic manufacturers and consumer services.
Also think about diversifying across credit and spread products, especially asset-backed securities, and real assets, select hedge fund strategies, preferred securities and emerging market (EM) debt.
This article is based on Lisa Shalett’s Global Investment Committee Weekly report from February 10, 2025, “Passing the Baton, Gently.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.