26 Mar 2024
This month, we take a look at the so called Magnificent Seven stocks that have driven the US equity market over the last 12 months. The US equity market is a very large component of global equity markets (circa 70%), and trends in this market often impact markets globally.
US Equity Market Performance
In calendar year 2023, the US equity market (S&P500) performed well, posting a ~26% return (in USD). This performance was largely driven by just seven stocks, which have become known as the “Magnificent Seven”.
Change in total market value since October 12, 2022
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Source: FactSet, as of 19/01/2023.
Collectively, the Magnificent Seven posted a 107% return in 2023, accounting for more than 60% of the S&P500 return of 26% (in US Dollar terms).
Magnificent Seven
The seven stocks in the Magnificent Seven are listed in the table below, along with performance metrics in US Dollar terms.
As at 19/03/2024, in USD terms. Meta Platforms was formerly named Facebook.
Each of these seven stocks has been driven by various factors and market themes, some of which are noted below:
- Artificial Intelligence (AI) – NVIDIA and Microsoft are the key market leaders in AI. NVIDIA makes the world’s most powerful computer chips used for AI computation, while Microsoft is the leader for usable AI tools. We will write a separate note on AI in the coming months.
- Financial health – strong balance sheets and huge cash generation.
- Earnings growth – many of these companies have posted very strong earnings growth, and market expectations for future earnings growth are also very strong.
- Operational improvements – Especially true for Meta, with large changes in governance and monetisation of their services.
- Cost reduction – many of these companies have demonstrated strong cost discipline through headcount reduction, and ensuring they are allocating cash to profitable projects.
- Innovation – very high spending on research and development have led to many new and market leading product launches.
- Market leaders – all seven companies are market leaders in their operating segment, with significant competitive advantages above their competitors.
- Rate cuts – expectations of significant rate cuts in 2024/2025.
- “Soft landing” – expectations of an economic “soft landing” versus previous fears of recession.
Since the start of the year, we have seen some divergence in returns across the Magnificent Seven. NVIDIA continues to be a very strong performer, almost doubling the share price since the start of the year, however Apple and Telsa have begun to lag. Consensus earnings expectations for Telsa have been revised down, while NVIDIA expectations continue to shift meaningfully upwards.
What does this mean for markets?
Over the last 18 months, almost all the earnings growth in the S&P500 has come from the Magnificent Seven, so while these stocks have driven the broader market, the earnings have also been very strong.
Many investors have raised questions about the valuations of these companies given the very strong performance. Some have also compared their share price growth to the rapid share price gains of tech stocks in the early 2000s, in what became known as the Dot Com Bubble. Whilst there are some similarities, we don’t currently feel that the Magnificent Seven is another Dot Com Bubble event. In the Dot Com Bubble, many of the companies that ended up failing or losing significant value were either not making any money, or were valued at very high levels relative to the little earnings they did generate. This is not the case for most of the Magnificent Seven, which are highly profitable and generating very large amounts of cash. Whilst valuations on these names don’t look cheap, their market leadership looks set to continue in the short term.
Risks
Whilst many of these seven stocks continue to perform strongly, given the strong momentum in markets, they are not without risks. These include risks that their earnings prove to be more cyclical than the market currently expects; risks that forward earnings disappoint versus current lofty expectations; risks that competition increases versus the current valuations which assume little to no competition; and regulatory risks. Any of these may result in significant share price falls from here. Given the large size of these stocks in the market (ie. almost 30% of the US share market), share price falls here may have large impacts on broader equity markets.
Outlook
Current market momentum looks strong for these names, whilst strong consensus earnings forecasts for most of these stocks goes someway to supporting their higher valuations. However, looking more broadly, there is significantly better valuation support outside of these seven names in US and global equity markets for the current market momentum to be sustained, we do need to see a broadening of winners outside of the Magnificent Seven. Whilst the current momentum is positive for broader equity market returns, it does present a challenging environment for those investors with strong valuation processes and a preference for diversification (over concentrated bets). As always, sentiment drives short term price movements whilst individual company fundamentals sustain longer term price movements. With this, we expect markets to be driven by more individual stock specific factors over the coming years, which will include some of these seven names.
The Investment & Research team at PSK are always monitoring market conditions and data points to ensure portfolios align with our overall long-term objectives. If you’d like to discuss any of the points raised, please contact your Adviser or call us on (02) 8365 8300.
General Advice Warning - Any advice included in this article has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs.
