Navigating the Magnificent 7 Correction: Key Risks and Diversification Strategies in 2025

The recent Goldman Sachs report (January 29, 2025) analyzes equity market dynamics following a 3.5% correction in the “Magnificent 7” tech stocks. Here are the key insights:

Market Context and Outlook

• Correction ≠ Bear Market: The decline reflects valuation adjustments rather than recession-driven bear market conditions 1. Economists maintain a 15% recession probability for the next 12 months and expect modest rate cuts.
• Vulnerable Valuations: US equity valuations remain near 20-year highs (22.8x forward P/E), even when excluding Big Tech (19.9x) 1. Non-US markets show mixed valuations, with China being the notable exception 1.

Concentration Risks

• Structural Dominance: Three forms of concentration dominate markets:
  1. US equities (53% of MSCI World Index)
  2. Technology sector (27% of S&P 500)
  3. Single-stock dominance (Magnificent 7 = 25% of S&P 500) 1
• Fundamental Drivers: This concentration reflects superior fundamentals: US profit growth outpaced non-US markets by 2:1 since 2014, while tech sector EPS grew 400% vs. 150% for non-TMT sectors since 2009

Emerging Challenges

• AI Capex Paradox: $1.2 trillion in projected tech capex for 2025 raises questions about:
  • ROI for incumbent spenders vs. new entrants
  • Need for complementary infrastructure growth 1
• DeepSeek Disruption: The Chinese AI firm’s aggressive pricing has introduced competition in foundational models, potentially accelerating margin pressures.

Investor Positioning and Opportunities

• Dangerous Consensus: Conference polls revealed extreme positioning:
  • 58% expect US equities to outperform in 2025
  • 42% favor tech sector continuation.
• Diversification Pathways:
  • Geographic: Europe (+6% YTD) and Japan showing relative strength
  • Sectoral: EX Tech Compounders (ETCs) outperforming tech since January
  • Asset Class: Bonds rallying during equity selloffs 

Forecasts and Strategy

• Earnings Convergence: 2025 EPS growth expectations show narrowing gaps:
• Mag 7: 16% vs. S&P 493: 13%
• US/Europe/Japan all clustered near 10-11%

Tactical Recommendations:

• 1. Hedge US equity exposure with put options
  2. Increase allocations to equal-weight indices (S&P 400/Russell 2000)
  3. Build positions in European industrials and Japanese financials.

The report concludes that while structural supports remain, investors should use this correction to rebalance portfolios toward less crowded exposures with better risk/reward profiles.

Primary Source: Global Strategy Views Concentration & Correction: What to do next