While investors would have been worse off if not for the Magnificent Seven, we wondered: Has it always been more important to hold the stock market’s top contributors, or have there been times when it was more important to not hold the market’s biggest detractors?² Now unfolding is a study in market cyclicality.

To answer this question, we replicated the constituents of the Russell 3000 Index to reflect its changing makeup over the period from January 1, 2000, through December 31, 2023. Then we split the 24 years into 12 two-year subperiods, calculated each stock’s contribution to the index return, and simulated alternative courses of history for the U.S. stock market by excluding entire groups of stocks from both ends of the contribution distribution.³

The bars in the chart that follows show the net effect in each subperiod of excluding both the top contributors and the biggest detractors from the Russell 3000 Index.

A look across all 12 two-year periods reveals an interesting pattern. In the early years of our analysis, it generally was more important to avoid the worst detractors, because they weighed on the market more than the top contributors helped it. In the latter years of our analysis—that is, the Magnificent Seven era—it has been more beneficial to hold the top contributors than to avoid the biggest detractors.

The circles in the chart suggest that the relative importance of contributors and detractors coincides with the return differential between large- and small-caps. When large-caps underperform (that is, when the dot is below the x-axis), the gain of not holding the biggest detractors tends to exceed the loss of not holding the top contributors. Conversely, when large-caps outperform (that is, when the circle is above the x-axis), the loss of not holding the top contributors tends to exceed the gain from not holding the biggest detractors.

The data reflect how large-caps dictate the market’s “direction of travel.” This makes intuitive sense, because a stock’s contribution to the market return is a function of the stock’s return and its market weight. If two stocks deliver the identical return in a given period, the one with the higher market weight will contribute more to the market return.

Of course, had one correctly predicted the (change in) performance of large-caps versus small-caps or the rise of the Magnificent Seven, one would have easily outperformed the market over our study period. But we know from numerous studies on the performance of professionally managed active funds how difficult an undertaking this is.

Our findings should be a reminder of the challenge of market timing. For active investors who are not comfortable with market timing, diversification and maintaining discipline can improve their chances of outperforming.

• Our investment and economic outlook, May 2024 (article, issued May 2024)
• Improving investing outcomes by minimizing investor bias (article, issued May 2024)
• Is there (n)ever a good time for active? (article, issued May 2024)