Mag 7, or Lag 7?

I have been an advocate of holding a barbell position of U.S. large-cap growth and EAFE value stocks in equity allocations. More recently, the EAFE value portion has outperformed while the U.S. large-cap growth component has lagged. As a consequence, I am increasingly seeing questions of whether it’s time to rethink the allocation to U.S. large-cap growth stocks.
 

 

As the underperformance of U.S. growth is mainly attributable to weakness in the Magnificent Seven names. The question becomes: Has the Mag 7 become the Lag 7?
 

 

Magnificent Seven Fundamentals

To answer that question, I begin by reviewing the fundamentals of the Magnificent Seven stocks, which mainly translates into the fundamentals and expectations of the AI boom.

The history of the AI boom is evident when analyzing the evolution of operating margins of the S&P 500. Most of the margin expansion in the last two years has come from technology stocks.
 

 

The margin expansion story may be about to change. Analysis from FactSet shows that while earnings growth expectations of the Magnificent Seven lead the S&P 493, the expected growth differential between Q4 2025 and CY 2006 is narrowing.

 

If the underperformance of large-cap stocks is based on changes in expectations, a bull case can be made by observing that cap-weighted 2026 earnings revisions are outperforming equal-weighted earnings revisions.
 

 

 

Too Far, Too Fast

Arguably, the recent underperformance of U.S. large-cap growth is a case of a group of stocks that became overbought and staged a reversal. The accompanying chart shows the relative performance of the Russell 1000 Growth to Russell 1000 Value ratio. The ratio became overbought in early November, as measured by the 14-day RSI, and recently fell to an oversold reading. Similar episodes in the last five years have led to bounces, though it’s an open question as to whether a reversal is durable.
 

 

Indeed, the pullback in technology and growth stocks reached a phase that the forward P/E of the technology sector fell to second place behind the forward P/E of the consumer discretionary sector.
 

 

From a technical perspective, U.S. large-cap growth is washed out and ready to bounce. The NASDAQ 100, which is a proxy for large-cap growth, has staged a rally but pulled back from overhead resistance. Relative breadth indicators (bottom two panels) are showing signs of improvement.
 

 

 

The Value of Diversification

Putting it all together, how should investors react to the recent weakness and recovery in U.S. large-cap growth? Is the strength in the Magnificent Seven over?

First of all, investors need to recognize that we are in a bull market. Global breadth is strong, as represented by the percentage of global markets within 5% of one-year highs. If history is any guide, such episodes tend to resolve in high stock prices in the future. Even if the Magnificent Seven were to falter in the intermediate term, it should be regarded as an episode of leadership rotations.

That said, it remains an open question whether the reversal in U.S. large-cap growth stocks is short term in nature. An analysis of the growth and value relationship across different market cap bands and internationally shows that value remains dominant. The most plausible scenario in such a situation is a relative consolidation in U.S. large-cap growth and value in the short run.
 

 

My crystal ball is cloudy. Under such conditions, I continue to believe investors should maintain a diversified allocation to the barbell strategy of U.S. large-cap growth and EAFE value in their equity allocations.