Magnificent Seven giants ‘still not overvalued’

The Magnificent 7 tech giants aren’t becoming increasingly expensive in relative terms, according to one US broking giant, as earnings estimates for most of the group are surging.

The Magnificent 7 tech giants are still driving the US stock market and they’re not overvalued yet according to J.P. Morgan

Australian shares have had to contend with plunging iron ore prices but the Magnificent 7 tech giants are still driving the US stock market and they’re not overvalued yet according to J.P. Morgan.

After surging since October on expectations of widespread interest rate cuts after dovish signals from the Fed as inflation slowed, the US share market seemed vulnerable to a correction as the number of cuts expected by the money market roughly halved in the first three months of the year.

Nvidia suffered an 11 per cent intraday fall on Friday suggesting it might be overcooked.

But by Tuesday, Wall Street appeared more likely to experience a rapid “melt up” to record highs.

While most asset classes took a modestly hawkish signal from slightly higher than expected core CPI data this week, the S&P 500 rose 1.1 per cent to a record high close, led by a 7.7 per cent rise in Nvidia. To put that move in perspective, Nvidia added more value to the US share market in a single day than the entire market capitalisation of Australia’s biggest company, BHP Group Limited.

It was a similar situation when US CPI data overshot expectations last month.

The US rebound lent support to the Australian share market, supporting the S&P/ASX 200 above its uptrend line near 7700 even as iron ore futures fell almost 5 per cent to four-month lows near $US104.35. Iron ore has dropped 25 per cent since January.

BHP shares fell 1.3 per cent to a more than nine-month daily closing low of $41.95.

However, major banks mostly rebounded toward multiyear highs with Westpac up 1.8 per cent.

Based on Fed chair Powell’s comments last week, the Fed is determined to start rate cuts soon.

Market pricing is now more in line with the Fed’s latest projections of three interest rate cuts this year, but traders will keep a close eye on its “dot plot” next week.

US disinflation momentum may be stalling, but the CPI data showed a sharp normalization in non-housing services inflation and a fall in the owners’ equivalent rent category.

Still, communications prices rose sharply for a second straight month and will boost the important PCE inflation measure at the end of the month, said Goldman Sachs chief economist, Jan Hatzius.

Thursday’s release of US PPI inflation data also feed into expectations for the PCE data.

Based on how easily it brushed off the CPI data, the US stock market is also likely to look past the PPI data unless they’re much higher than expected. Nvidia and other AI stocks will be key.

Oracle soared 12 per cent on Tuesday on a stronger than expected sales forecast.

Nvidia’s GTC 2024 AI conference and expo for developers from March 18-24 is a key focus.

Nvidia’s CEO Jensen Huang’s keynote address on March 18 will be a much-watch for AI investors.

“Tactically, the risk of a strong run into Nvidia’s GTC conference seems real, although this sets the stock up for a sell-the-fact type event,” said Chris Weston, head of research at Pepperstone.

Nvidia one-month 25 delta call implied volatility was traded at a 9 vol premium to puts on Tuesday.

“This is rare and essentially shows that options traders feel if there is to be a move then it will be far more pronounced to the upside than downside – truly bullish expectations,” Mr Weston added.

Of course the Magnificent 7 tech giants that account for about 30 per cent of the S&P 500 are driving a disproportionate share of returns and there are concerns over how sustainable this is.

However, J.P. Morgan finds that this group of stocks isn’t becoming increasingly more expensive, at least not in relative terms, as earnings estimates for most of the group are surging.

“In fact, Mag-7 stocks appear cheaper at present versus the rest of the market than they were trading on average in the past five years,” said J.P. Morgan’s head of global and European equity strategy, Mislav Matejka.

In absolute terms, he says “there appears to be an excess”, and Mag-7 could disappoint on earnings, proving to be more cyclical, but there’s little sign of that outside of Tesla and possibly Apple.

More broadly, the growth style – dominated by the Magnificent 7 - is also supported by the continued better earnings delivery versus the value cohort.

That’s why J.P. Morgan has favoured growth over value stocks through 2023 and into 2024.

Outside the Magnificent 7, earnings for S&P 500 companies have actually been negative in the past few quarters, and J.P. Morgan sees risks to the consensus view that continues to argue for the re-acceleration in earnings across S&P 500 companies this year.

Mr Matejka warns that valuations are becoming stretched in cyclical sector groups, with European cyclicals trading at more than one standard deviation expensive versus defensive stocks.

“Cyclicals in general are at price relative highs versus defensives, as high as in 2009-2010, when the synchronized global recovery did materialize,” he said.

“Such an acceleration might be the wrong template this time around, consensus hopes for cyclicals’ earnings rebound could falter.”