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The ‘Magnificent Seven’ – bubble or room to run?

We look at the seven largest companies in the US, their impact on the overall stock market and whether or not they’re approaching bubble territory.

Important information - This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

It’s not uncommon to have a group of companies lead an index. In fact, in the US over the last 20 years, the top seven companies have typically accounted for between 10-20% of the index (S&P 500). But since around 2017, there’s been a consolidation of power. The top seven now account for 29% of the overall index.

The concentration at the top from the largest seven companies (the so called Magnificent Seven) is starting to draw comparisons to bubbles of the past.

Let’s see whether those comparisons have merit, and if these big names can still offer some value for investors.

This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments can rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future and ratios shouldn’t be looked at on their own.

Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

How did we get here?

There’s been a lot of talk this year about the mammoth performance delivered by the big seven, and that’s certainly true. The US stock market is up 22% so far this year, but strip out the Magnificent Seven and that number drops to 9%.

Impact of the Magnificent Seven

Past performance isn’t a guide to future returns.
Refinitiv Eikon 11/12/23. US market represented by SPDR S&P 500 ETF (includes ETF charges).

2023 has brought with it a wave of new enthusiasm for megatrends like artificial intelligence (AI) and the biggest players in the market all have their fingers in the pie. Add in some favourable macro-economic data and the potential for interest rate cuts next year, and it’s been a recipe for good tidings.

But, if you’re a believer in mean reversion (what goes up must come down) then it looks like it could be time to take some profit and run. But let’s take this back another year, and the picture starts to change.

Impact of the Magnificent Seven

Past performance isn’t a guide to future returns.
Refinitiv Eikon 11/12/23. US market represented by SPDR S&P 500 ETF (includes ETF charges).

2022 was a horrible year for the big seven, losing close to 50% of their combined value. With a two-year lens, it looks less like a run up and more like a recovery.

So, what’s the real takeaway from this?

Don’t rely on past performance or news headlines to make decisions. Depending on the timeframe you use, the picture can quickly change.

SPDR S&P 500 ETF five-year performance

2018 - 2019

2019 - 2020

2020 - 2021

2021 - 2022

2022 - 2023

24%

17%

29%

-12%

20%

Past performance isn't a guide to future returns.
Refinitiv Eikon, 15/12/23.

Another bubble?

One of the first arguments you’ll often hear for why these stocks are overvalued, even in bubble territory, is their valuation.

It’s true, when looking at price-to-earnings (PE) multiples the top seven stocks in today’s market are expensive. And there’s certainly some comparison to previous bubbles like in March of 2000, just before the dot-com bubble burst.

Magnificent Seven

Trailing PE

Forward PE

Meta

29

19

Amazon

77

42

Apple

32

29

Alphabet

26

20

Microsoft

36

31

Nvidia

63

25

Tesla

79

65

Average

49

33

Dot-com giants

Trailing PE

Forward PE

Intel

53

36

Cisco

169

107

Exxon

33

24

Microsoft

53

53

GE

40

36

Oracle

143

91

Walmart

40

36

Average

76

55

Refinitiv Eikon 11/12/23. Dot-com giants’ data as at March 2000 reflects the seven largest companies at the time. Trailing PE looks at the previous 12 months earnings, Forward PE considers the consensus forecast for earnings over the coming 12 months.

If we look at the seven biggest names from both era’s, the first thing standing out is the stark difference between trailing and forward PE’s. When we factor in projected earnings, current prices start to look more reasonable. They’re still high, but considering these are some of the best businesses in the world, it’s not surprising to see premiums applied.

From March 2000 to October 2022, Cisco, Intel and Oracle lost 75-85% of their value. Microsoft and GE lost 49% and 36% respectively. It was only Walmart and Exxon that escaped relatively unhurt out of that cohort.

But for us, it doesn’t look like the current big seven are in any imminent danger of toppling over.

Valuations have some froth (the S&P 500 excluding the seven has a forward PE of 17) but aren’t quite at the levels seen prior to previous bubbles. These are also highly profitable businesses, with rock-solid balance sheets. Though of course, there are no guarantees.

And so, the real question is – do they have further room to run?

The rate conundrum

Interest rates have pretty much dominated market dynamics for the past year. We’re now sitting in a position where markets expect things to have peaked, with cuts priced in over 2024.

Companies trading on higher earnings multiples, like the Magnificent Seven, are more sensitive to rate changes than others. That’s because higher rates tend to reduce the value of future earnings, while lower rates do the opposite.

The hope for rate cuts into 2024 is therefore a tailwind for the more growthy names out there.

But are markets getting this one right? We think perhaps not.

Markets are expecting several interest rate cuts over 2024, taking the rate from its current level of 5-5.25% down to 4-4.25% by the year end. The problem is that’s severely out of sync with the projections given by members of the US central bank. So much so that for markets to be right, every single member would have to be wrong.

If interest rates stay above what is currently predicted, this could act as a headwind for high growth names over the course of 2024.

The key takeaway for investors

We don’t think the big seven is a bubble that’s about to burst. But we would urge investors to check their exposure after what’s been a massive year for a select group of stocks.

2024 looks set to bring another year where interest rates dominate the narrative, and preparing for higher for longer could be a good way to go.

Is it time to ditch exposure to the Magnificent Seven? Certainly not.

Quality businesses with exposure to long-term growth drivers can keep performing well in a range of environments and should rightly demand premium valuations.

However, it could be a good time to look for some of the more unloved areas of the market and make sure you’re well diversified.

Unless otherwise stated estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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Written by
Matt-Britzman
Matt Britzman
Equity Analyst

Matt is an Equity Analyst on the share research team, providing up-to-date research and analysis on individual companies and wider sectors.

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Article history
Published: 15th December 2023