The "Magnificent Seven" are falling by the wayside. Which companies should you look out for?

The usual obsession of investors with the shares of the "Magnificent Seven" is gradually losing its relevance: the growth rate of the IT giants' securities is slowing down, according to BofA Global Securities. Instead, market participants advised to take a closer look at two other groups of stocks - the Terrific 20 and the Forgotten 50.

The "Magnificent Seven" stocks are losing momentum before the start of the fourth quarter, while gains are spreading to other parts of the market, Barron's wrote, citing a note from analysts at BofA Global Securities. That could be bad news for funds tied to the S&P 500 and weighted by market capitalization and therefore dependent on the biggest names, the publication noted.

"Megacaps are slowing down. Expect strong growth and EPS (earnings per share. - Oninvest) expansion, but less impressive index returns," said BofA strategist Savita Subramanian.

New groups of companies are coming to the forefront that are shaping a different dynamic in the S&P 500 and changing the leadership picture, Pictet Asset Management senior strategist Arun Sai and Pictet Asset Management senior investment manager of thematic assets Gertjan van der Geer write in a column for Barrons. They call these groups the Terrific 20 (the "Terrific 20") and the Forgotten 50 (the "Forgotten 50").

"The Terrific 20" are twenty of the largest companies from the consumer discretionary, financial and energy sectors, highlighted by Broadcom, Visa and Netflix. Over the past year, this group's stocks have risen 11% more than the "seven" stocks. That has taken the S&P 500 back to a cyclical high, with a price-to-earnings (P/E) multiple of 22, suggesting that the market has gotten broader, and growth is no longer solely based on Nvidia, Microsoft and the rest of the "Magnificent Seven," Say and Van der Geer write.

However, this success has a downside. Unlike the Magnificent Seven, the companies in the Terrific 20 show far more modest financial results. Their capitalization has soared 60% in two years, but their share of total returns in the S&P 500 has fallen from 20% a decade ago to 15% today. This creates a contradiction: valuations are rising, but fundamentals are not improving.

Nevertheless, this does not mean that investors should completely withdraw from the U.S. market. On the contrary, they have an opportunity to rotate their capital. Leadership may shift from overvalued stocks to companies that are currently undervalued despite strong fundamentals, Pictet Asset Management managers believe.

Such candidates, according to Say and van der Geer, are the "Forgotten 50" - fifty corporations that have been undeservedly overshadowed. Their capitalization is only 5% of the S&P 500, and their price-to-earnings ratio is one-third below the long-term average. The reason has been an excessive cooling of expectations, but in parallel these companies' earnings have risen 80% over the past two years. Some recognizable names among them are Salesforce, Chipotle and Eli Lilly.

The situation is such that popular growth companies may be replaced by new leaders, providing a healthier foundation for the market. Investors should probably reduce over-concentration on expensive "megacaps" and look towards quality but undervalued companies. Diversification, shifting focus in favor of the "Forgotten 50" and companies with strong earnings dynamics at low valuations may become not only insurance against correction, but also a source of future profits, analysts believe.

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