‘The Magnificent Seven falter, but the bull market remains’

There is a pervasive belief that the “Magnificent Seven” tech stocks are the drivers behind the relentless rise of the US stock market. The Magnificent Seven, sometimes called the Mag 7, are Nvidia, Amazon, Alphabet, Microsoft, Apple, Meta and Tesla – seven of the largest companies in the US and therefore the world.

But the Magnificent Seven no longer ride together and their performances this year are very different. The S&P 500 has returned 13.4% year to date. Amazon has returned 21%, but Tesla -25%. In between are Nvidia (19%), Apple (16%), Alphabet (12%), Microsoft (6%) and Meta (0.4%). As a result, Meta and Tesla have been pushed down the list of the world’s largest companies by TSMC, Broadcom, SpaceX and Saudi Aramco, now in sixth, seventh, eighth, and ninth place, respectively.

Fifteen companies in the S&P 500 have more than doubled in value this year, led by Sandisk (+413%), Dell (+255%) and Micron (+207%). None of the Magnificent Seven come in the top 150; Tesla is near the bottom. As strategist Ed Yardeni notes, the Magnificent Seven are up just 4.8% this year against 16% for the remaining “impressive 493”. Information technology is still the S&P’s second-best-performing sector (up 23.6% against +28.4% for energy), but the Magnificent Seven no longer lead it.

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The Magnificent Seven have invested heavily in AI

The dull performance may be accounted for by investors’ concern about the gigantic amounts of money these companies are investing in AI. This may seem like collective insanity, but these companies are led by and employ many of the smartest people in the world. How likely is it that they are wrong and the itinerant pundits, with limited knowledge and experience, are right? In any case, any fall-off in investment and thereby an increase in cash flow could lead to renewed outperformance.

Yardeni notes that the forward multiple of earnings of the S&P 500 Growth index has fallen to 20.2 against 18.3 for the Value index. In 2000, he says, Growth traded on a multiple above 40. Growth’s forward earnings have been boosted by mark-to-market capital gains, so the multiple of sustainable forward earnings is higher but, he points out, “bull markets do not die of old age or of accumulated gains. They usually die when earnings roll over.”

The driving force of the bull market is then “FEMO” – fabulous earnings momentum, rather than “FOMO”, or fear of missing out, as in the late 1990s. “In the current bull market, the S&P 500 is up 117% since it began on October 2022. That ranks fifth of the eight bull markets since 1969.” Taking a longer-term perspective, the index is up 277% since 2015, but between 1985 and the millennium, it was 625%. “If the analogy continues to hold and the market keeps climbing, the interesting years are ahead rather than behind.”

How other markets are faring

Yardeni also monitors sentiment, which suggests that institutional investors are bullish (a contrary indicator), but “retail investors not so much”. Markets do not go up in a straight line, so a setback or period of sideways trading would be likely to dampen sentiment, paving the way for a further advance. The chances of a serious setback to earnings growth are small; if the Gulf war and its effect on oil prices could not achieve that, what could?

Elsewhere, the outlook is at least as good. The reliably pessimistic and risk-averse British have led to a serious undervaluation of the UK market and a takeover bonanza for private equity and overseas bidders, which shows no sign of slowing. The yen, at last, is showing signs of stabilising if not reversing its 15-year bear market. This would mean that the strong underlying performance of the Japanese market would look even better for overseas investors.

The outlook for the European economy is improving while its companies have successfully globalised. Technology companies in emerging markets are doing even better than in the US with year-to-date performance of 32%, so South Korea (+71%) and Taiwan (+62%) lead the country performance table even after the recent setbacks. Earnings growth in the MSCI All Countries World index ex US has been pedestrian in the last three years, but is about to accelerate sharply, with 34% growth expected in the next 12 months.

Further evidence of a broadening market comes from the improved performance of smaller companies, with the Russell 2000 index for the US hitting record highs and outperforming the S&P 500 over the last year. Small caps in the UK, Europe and Japan have continued to underperform, but performance has picked up and may be moving ahead.

This is not the end for the bull market

The outperformance of the Magnificent Seven in recent years looks like having been a passing phase. Its end does not signal the end of the bull market, much less an imminent collapse, but a healthy return to the traditional pattern whereby mega-caps lag a broadly advancing market.