The same pattern played out again last week: the market sold off for a few days then buyers showed up and bought the dip. The questions around whether this was finally the top for the AI trade never actually got answered. Buyers seemingly got tired of waiting and stepped back in. There are three things worth keeping in mind while this plays out.

Seven names still rule

Investing in the S&P 500 today means roughly a third of that money is (still) riding on seven companies. Nvidia alone is nearly eight percent of the index, Apple is close to seven percent, Microsoft another four point six percent. Add Amazon, both share classes of Alphabet, Meta, and Tesla, and you’ve got nearly thirty-three percent of the index. The other four hundred ninety-odd companies split the remaining two thirds. None of this is a knock on the index, per se, but it is worth seeing the splits plainly before deciding how much of a portfolio should mirror it.

The Mag 7 rule by weight, however, and not by recent performance. As a basket, they are down roughly three percent year-to-date, even as the semiconductor index has climbed close to eighty percent. The group is committing trillions to the AI buildout, and much of the return on that spend seems to be captured by the chipmakers they buy from rather than the buyers themselves. Nvidia straddles both sides of that trade, standing as a Mag 7 name and also the chief supplier, so the drag on the basket is appearing from the other six. The market, for its part, is pricing those suppliers as though the demand never lets up.

Concentration is the risk, not jumpiness

While the instinct might be to treat the megacaps as the white-knuckle holdings, a closer look at the individual securities shows that they were not as volatile as they are sometimes made out to be. According to Pave’s optimizer risk measures, the Mag 7 were among the steadier names in the market last week. Risk actually climbed as market caps decreased, with the smallest stocks carrying the most risk by a wide margin.

The exposure in the index is not that any one of the Mag 7 names is volatile, but that so much of the index’s direction depends on the same handful of stocks. Those seven sit in just six industries (mostly semiconductors, software, and internet services) while the index as a whole spans more than one hundred sixty. When a few names are concentrated into a third of the market that tend to move together, there is little holding the index up if they sell off in unison.

Small but mighty

Small caps are a different animal. The spread of risk across small cap names was close to twice that of the S&P 500. In plain terms, the gap between the best and worst stocks at the bottom of the market-cap spectrum is far bigger than it is at the top of the market. Owning small-caps seems to cut both ways, as the group saw a rally last week.

The June 26 Russell reconstitution, now a semi-annual event, underlined the broadening. The Russell 3000’s total market cap rose twenty-nine percent from a year ago to $75.6 trillion, and the whole distribution shifted up with it: the line dividing large caps from small caps climbed twenty-four percent to $5.7 billion, and even the smallest name in the Russell 2000 was up roughly twenty-three percent. Technology and Industrials led the companies graduating out of the Russell 2000 and into the Russell 1000, with SpaceX joining the large caps under a new fast-entry rule. A record $334 billion changed hands in the Nasdaq closing cross to settle it all last Friday.

Still, indexing the whole cohort buys that dispersion without sorting through it. Which names you hold counts far more here than it did among the megacaps. The same logic stands for tilting the rest of the book toward stocks that do not march with the megacap leaders. None of this is about calling a top or guessing the next move, but to point out how owning the index is not the same thing as owning a diversified portfolio. With a third of the index latched to one cluster of tech, the other one hundred sixty plus industries are where real diversification still remains.

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By Stephen Evans, CFA

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