Move over Mag 7, there may be a new game in town

The top 10 stocks now account for almost 38% of the S&P 500, one of the highest levels of market concentration in history. For those riding that concentration, life has been good.

However, at a Franklin Templeton briefing last week, ClearBridge’s Jeff Schulze, made a compelling case that this dynamic may finally be starting to change.

"We have been calling for a broadening of market participation into the lagging areas - small caps, non-US and value. We've seen that over the last six months. We think that there's more to go on that front. 

"And then lastly, due to market concentration, we think that active managers have a competitive advantage versus passive indices in the next five years," he says.

The Magnificent Seven outperformed because they were "the only game in town" when it came to earnings growth. As that advantage narrows, the next winners may increasingly come from small caps, international equities, value stocks and emerging markets tied to the AI supply chain.

In this wire, Schulze explains why four decades of market data suggest the era of narrow leadership may be ending, and where the opportunity is opening up.

Why the Mag 7 dominated and why that's changing

For the better part of three years, the Magnificent Seven dominated the market through sheer earnings growth, while the rest of the market was stuck in an earnings recession.

That backdrop is changing, with Schulze terming the Q1 2026 earnings as “blockbuster”, and the breadth of those results was significant. The median S&P 500 stock delivered 16% earnings growth, the strongest in four years. Revenue came in at nearly double the long-term average and guidance was strong across the board.

"When earnings growth is abundant, investors are going to rotate to those cheaper sources of earnings growth, which is the rest of the US equity complex."

While the Mag 7 still has an earnings advantage in 2026, Schulze believes it has narrowed considerably. With cheaper parts of the market growing at comparable rates, the case to rotate out of Mag 7 names becomes compelling.

According to Schulze, the areas best positioned to benefit include:

• US small caps
• Value companies
• Global equities outside the US
• Emerging markets
• Active managers positioned away from benchmark concentration

This is not dot-com 2.0

While I’ve heard others compare this time to the dot-com bubble of the 1990s, Schulze pointed out that today’s market looks fundamentally different from 1999.

Back then, returns were driven almost entirely by speculative multiple expansion with little earnings foundation beneath them. Today the picture is almost the exact opposite.

"Last year, tech price-to-earnings ratios went down dramatically and it was 100% driven by earnings. Over 100% of the S&P 500 gains over the last year were driven by earnings."

Schulze also noted that the S&P 500 has traded above a forward P/E of 20 for over 65% of the past six years, returning 150% over that period, driven almost entirely by earnings growth rather than multiple expansion.

The concentration problem passive investors aren't thinking about

Most Australian investors holding a US index fund probably don't realise they're making a concentrated bet on just ten stocks.

For a long time, that concentration has been the winning strategy, however Schulze argues that the very thing that has powered those returns may now be the thing investors should be most cautious about.

Schulze pulled out 40 years of data to show what typically happens next and on the way up, the numbers are impressive. 

In the three years before entering the top 10, the average stock outperformed the benchmark by 33.5% per year. Once a company reaches that milestone, however, the picture tended to change.

"Trees don't grow to the sky, and that certainly applies to becoming one of the largest companies in the S&P 500. Ten years later, you've underperformed the index by 5.8% per year on average."

His reference point is March 2000. Of the 10 largest companies at the dot-com peak, four had negative price returns over the following 26 years, and not one outperformed the equally weighted S&P 500.

Schulze remains constructive on markets overall, though he argues active managers who can identify which of today's giants will hold their competitive moats and which won't have "a core competitive advantage we really haven't seen in over 20 years." 

The overlooked opportunity in small caps and international equities

When it came to opportunities, Schulze pointed to several areas, all connected by what he calls the “democratisation of AI”.

As models become cheaper, smaller and easier to customise, Schulze believes the productivity benefits will increasingly spread beyond mega-cap technology.

"Mega-cap tech, they run very lean and mean, but that's not the same as a small cap company or mid cap company or a non-US company as well. As smaller companies start to employ these models, I think they're going to be able to strip out a lot of costs."

On small caps, he was optimistic but selective. Small cap guidance came in at 1.5 times above-to-below in Q1, historically a strong signal, and the valuation gap to large caps has widened considerably. 

He pointed out the key risk as the Fed – if rates rise rather than fall, the picture changes significantly. His base case is one to two cuts over the next 12 months, keeping conditions broadly supportive.

Global equities outside the US were another standout. When the top 10 S&P 500 stocks exceed 24% of the index, non-US markets have historically outperformed by 2.4% per year over the following five years. 

Non-US stocks still trade at a six-turn P/E discount to the S&P 500, double the historical average of three turns, even after 16 months of outperformance.

Emerging markets were another area that Schulze believes investors may be underestimating.

"About 40% of the MSCI emerging market index is tied to AI in one way, shape or form. The valuation gap between emerging and developed markets is near record levels. It's under-owned."

With the current administration flagging a weaker US dollar as a policy goal, that tailwind could add further momentum to the case.

The commodity angle Australian investors shouldn't ignore

Closer to home, Schulze also had a clear view on commodities.

"I think we're probably in the beginning of a multi-year period where commodities are going to be moving higher. 

There's a desire for supply chain redundancy, electrification of the grid, all of these things are going to be driving commodities. Commodity cycles are notoriously long. You need five to 10 years to bring on a major mine and you really haven't started to do that. The cure for low prices is low prices."

None of this means the Magnificent Seven suddenly stop winning. But according to Schulze, after years where they were “the only game in town”, the opportunity set may finally be broadening, from small caps and international equities to emerging markets and commodities. 

For investors, the next winners may increasingly come from the parts of the market overlooked during the Magnificent Seven era.