How to Choose Among the “Other 493” Stocks

Jul 30, 2025

Tech giants are again dominating U.S. equity indexes. Investors should look for opportunities below the surface.

Author
Lisa Shalett

Key Takeaways

  • The S&P 500 is heavily concentrated, with the top 10 companies making up over 34% of its market cap, increasing volatility risks.
  • Beyond these tech giants, many stocks in the index have more reasonable valuations, offering potential for earnings surprises.
  • Investors may want to consider select tech stocks and others in financials, industrials, energy and parts of healthcare.

Equity investors seem to be enjoying the dog days of summer, driving stocks higher as they are emboldened by the markets’ ongoing resilience and the consistent success of “buying the dip.”

 

Passive U.S. stock indexes have been steadily reaching new records, and the market’s key volatility gauge remains benign. Cyclical stocks, which often rise when the economic outlook appears bright, are outpacing defensive equities by the widest margin in 18 years. Meanwhile, the most speculative corners of the market have begun to lead, with Bitcoin up sharply since early April and even meme stocks posting sizeable gains. What’s more, a measure of “cash on the sidelines,” or money that is not currently invested in the market, is at 25-year lows. And retail flows, a measure of trading activity by non-professional investors, has topped an impressive $75 billion in just the last three months. This all has left the S&P 500 Index extremely expensive.

 

While Morgan Stanley’s Global Investment Committee understands that lofty valuations, positive investor sentiment and market momentum alone are not necessarily reasons for caution, we believe the composition of this rally suggests risk, as well as opportunity.

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Wealth Management

Wash, Rinse, Repeat?

Emboldened investors are once again driving the S&P 500 higher, but risks lie under the surface. Market leadership is shifting, and the passive index is not the best way to play it.

The Risks of a Top-Heavy Market

Index concentration has returned with a vengeance: The S&P 500’s 10 largest companies by market capitalization now account for more than 34% of its total market cap, and just five of the so-called Magnificent 7 mega-cap tech stocks have gained in 2025. The “Mag 7” are now as expensive relative to all other S&P 500 index constituents as the biggest stocks were at the peak of the dotcom bubble. This sort of concentration in the S&P 500 can lead to greater volatility and the potential for significant drawdowns.

 

In particular, it’s important to note that as these tech giants continue to spend heavily on data centers and other generative AI infrastructure, they account for only about 20% of total S&P 500 company profits. Meanwhile, further below the surface, “market breadth,” a measure of the number of stocks rising versus those declining, is also weak, with only 9% of companies at 52-week highs – a shockingly low figure.

Opportunities in Stock-Picking

Carefully choosing individual stocks rather than passively investing in an index provides the advantage of exploiting the divide between the market’s highest fliers and the rest. Among the “other 493” stocks in the index, valuations are much more muted and closer to long-term norms. Earnings targets for many of these companies are also more achievable. This creates opportunities for discerning investors to add exposure to companies that can beat analysts’ expectations while selling those that are apt to disappoint.

 

The potential for differentiation is meaningful. Consider that there are mixed signals and headwinds in the economy. Airlines, restaurants, hospitality and apparel businesses have cut earnings projections and missed forecasts, and other companies have discussed the costs of tariffs and challenges in reconfiguring global supply chains amid policy uncertainty. However, others, like those in financials and fintech, are suddenly benefiting from an aggressive push for deregulation, with implications for payments, banking and credit.

How to Invest

The recommended way to play this dynamic is not through passive exposure to an overvalued benchmark equity index that focuses on winners of the past. Instead, the Global Investment Committee is looking forward, to a transition in which stocks beyond the Magnificent 7 catch up. This shift may leave the overall index stalled for now.

 

Given this backdrop, investors should consider adding long/short hedge funds and stocks with potential for upside surprise in earnings and cash flow. They may be found in select tech companies and other areas like financials, industrials, energy and parts of healthcare that may benefit from shifting U.S. policies.

 

Avoid overhyped themes, and consider adding diversifying positions in international equities, commodities and energy infrastructure.

 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from July 28, 2025, “Wash, Rinse, Repeat?” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report. 

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