The Rise Of The Magnificent Seven

As 2023 draws to a close, the financial world has been captivated by a group of tech giants, known as the "Magnificent Seven."

Their stock performance has been nothing short of remarkable, with gains ranging from a solid 50% to a staggering 219%.

Just who are these Magnificent Seven? 

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The financial markets have always been characterised by certain groups of stocks that dominate during specific periods.

In the past, we had the Nifty Fifty in the 60s and 70s (50 household American names such as Coca-Cola, Pepsi, Walt Disney, Avon, Polaroid, McDonalds) and more recently, the FAANG group, which included Facebook, Apple, Amazon, Netflix, and Google.

Then of course there have been the Dot Com stocks in the late 1990’s and the BRIC economies (Brazil, Russia, India and China).

Such groupings highlight the market's constant evolution, reflecting changes in economic conditions and the sentiments of investors.

Now we have the imaginatively titled Magnificent Seven, evolving from the original FAANG, with one member reluctantly bowing out and two others stepping into the spotlight.

The "Magnificent Seven" of course refers to Nvidia (NVDA), Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Alphabet* (GOOGL), Meta* Platforms (META), and Tesla (TSLA). They are the 7 largest companies in the US stock market (and the world) and they can all be described as tech companies (albeit Tesla have a foot in a few camps).

*Alphabet is the new name for Google and Meta is the new name for Facebook.

Performance Comparisons

Year to date, the Magnificent Seven have gained 71% while the other 493 stocks in the S&P500 have added just 6%.

Their outperformance is notable because eye-popping returns for top stocks tend to occur before they reach the top of the market.

Once there, subsequent returns tend to lag the market.

See below a graph showing the annualized returns in excess of the US market before and after joining the top 10 largest US stocks, January 1927–December 2022.

This could serve as a warning for those banking on the Magnificent Seven's persistent market dominance. Instead of chasing further gains in these mega-cap stocks, investors could be wise to diversify their portfolios broadly, positioning themselves to benefit from the success of any future market leaders.

Dot-Com Comparison

We've witnessed a similar trend during the dot-com boom at the turn of the millennium.

The first graph on the left delineates the market capitalization of the top seven tech stocks of that era (Intel, Cisco, IBM, Microsoft, Oracle, Merck, Qualcomm) compared to the present-day 'Magnificent Seven.' Back in 2000, these tech giants comprised less than 20% of the market index; the current seven now account for almost 30%, over a 50% increase.

The second graph, on the right, tracks the journey of these stocks since the peak of the dot-com bubble. We can see there has been huge dispersion in the returns of the companies that investors were most excited about at the time. A notable observation is that only Microsoft managed to surpass the overall performance of the S&P 500 during this period, while the rest have lagged behind, with some experiencing significant underperformance.

For instance, consider Cisco. It was the world's most valuable company at its peak, trading at about $77 in March 2000. Fast forward to today, and its value stands at just $49.

To Infinity And Beyond?

What's the future trajectory for these stock prices – can we expect their relentless rise to continue?

A key tool in assessing this is the Price-to-Earnings (P/E) ratio, a fundamental metric in stock market analysis. This ratio offers a snapshot of a company's valuation by indicating how much investors are willing to pay for each unit of earnings. For instance, a stock priced at £20 per share with an Earnings Per Share (EPS) of £2 would have a P/E ratio of 10, implying that investors are paying £10 for every £1 of earnings.

The graph below compares the current P/E ratios to their historical averages. Presently, US tech stocks are nearing an all-time high with a P/E ratio of 27.5, significantly above the average of 18, hinting at a potential overvaluation by about 50%.

US stocks overall are estimated to be around 20% overvalued.

On the other hand, UK stocks appear to be undervalued by approximately 40%.

This perception of undervaluation, particularly in the UK, might be influenced by our proximity to constant local negative news, a phenomenon known as 'home bias.'

We tend to be less exposed to similar news from other regions, like China, which is also seen as undervalued.

This raises a crucial question: Where is long-term growth more likely to occur? In the already dominant US market, or in undervalued domestic and emerging markets?

Note I’ve snuck in another stock acronym, the GRANOLAS. GlaxoSmithKline, Roche Holding, ASML, Nestlé, Novartis, Novo Nordisk, L'Oréal, LVMH, AstraZeneca, SAP and Sanofi.

Conclusion

The story of the "Magnificent Seven" in 2023 is a testament to the ever-evolving nature of the stock market. It highlights the potential of technology-driven companies to achieve remarkable growth but also serves as a reminder of the risks associated with chasing after stocks post-surge. Historical trends reveal that today's market darlings can quickly become tomorrow's cautionary tales.

A prime example is Netflix, the FAANG member that lost its bite.

At its peak, Netflix's stock reached a high of approximately $690 in November 2021, riding the wave of a world captivated by streaming services during prolonged periods indoors. However, as global circumstances shifted and life returned to a semblance of normality, the allure of endless streaming waned. This change in consumer behaviour was mirrored in Netflix's stock price, which plummeted to $273.411 by June 2022.

Just as in the iconic film, not all members of the Magnificent Seven are destined to survive. Who among them will mirror Yul Brynner's triumphant ride into the sunset, and who will echo James Coburn's untimely fate, falling before the battle truly unfolds?