AI's "Wealth Effect" is a House of Cards
The S&P 500 is up over 12% this year. Cue the celebratory headlines, right? But let’s peel back a layer. That headline glosses over a critical divergence: the "Magnificent Seven" (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) are doing the heavy lifting. Strip them out, and you're left with the "S&P 493," a very different beast indeed. The performance gap isn't just a curiosity; it's a flashing warning sign.
The Magnificent Seven vs. The Rest
The ‘S&P 493’ reveals a very different U.S. economy, comprised of smaller, lower-tech companies. These are the businesses getting squeezed by deglobalization and tariffs, as Moody’s Analytics points out. They lack the scale to absorb cost increases or shift supply chains easily. They're also more reliant on debt, making them vulnerable to rising interest rates. It's a double whammy: cost pressures and tighter credit.
Meanwhile, the AI boom is inflating the valuations of a select few. Nvidia, for example, has surged over 1000% in two years and is up 29% this year alone. Palantir, Micron, Vertiv – they're all riding the AI wave. Small caps, as measured by the Russell 2000, are down 4.5% over the same period. That's not just a discrepancy; it's a chasm. It suggests that the rising tide isn't lifting all boats; it's swamping the smaller ones.
Apollo's chief economist, Torsten Slok, nails it: one-third of the S&P 500 is concentrated in seven companies, making it effectively an "AI index." The index’s diversification function has effectively disappeared. Now, I’ve looked at hundreds of these market reports, and the speed at which this concentration is happening is genuinely unsettling.
The "K-Shaped" Market Reality
This divergence mirrors the broader "K-shaped" economy, where the wealthy are thriving while lower-income folks feel like they're in a recession (even without widespread job losses). Wealth is increasingly tied to the stock market, and the stock market is increasingly tied to a handful of AI-driven giants.
Mark Zandi at Moody's argues that the "wealth effect" from soaring AI stock prices is driving a significant portion of GDP growth – about half a percentage point, or one-fourth of overall growth. The problem? It's built on shaky foundations. Earnings expectations for the Magnificent Seven have increased by just under 4% between October and April of 2025, while the remaining 493 stocks in the S&P 500 have dropped by approximately 1.5%.
The market is rewarding AI hype, not necessarily underlying economic strength.
Hedge fund manager Michael Burry is already calling out the AI industry for "exaggerating its long-term profitability." And he isn't alone. The tech-heavy Nasdaq has already fallen 7% from last month’s peak.
The risk is that a big tech correction could trigger a broader economic slowdown. Consumer spending, particularly among high-income earners, is heavily reliant on the "wealth effect." If those gains evaporate, spending will dry up, and the economy will feel the pain. Consumers and corporations alike are in a very vulnerable position if the AI narrative wobbles.
