Will the ‘Magnificent Seven’ remain magnificent?

A lot has been said and written about the dominance of the US sharemarket by the “Magnificent Seven” mega technology stocks that have driven the market to record levels. Should a reliance on such a narrow slice of the market be a concern for investors?

Those stocks – Apple, Microsoft, Nvidia, Amazon, Alphabet (Google’s parent), Meta Platforms (Facebook’s parent) and Tesla – have dramatically outperformed the overall market.

The performance of the tech giants has driven Wall Street to record levels.Credit: AP

The New York FANG index, which largely reflects their performance, has surged almost 85 per cent over the past year and is up nearly 13 per cent so far this year. That’s a massive outperformance of the S&P 500, which has risen 36 per cent over the past year and is up 8.3 per cent year-to-date.

The contrast between the mega techs and the rest is even more stark if their performance is measured against the equal-weight S&P 500, which is “only” 18 per cent higher than a year ago and up 5 per cent so far this year.

The over-reliance on a handful of stocks could be seen as a vulnerability, particularly given the nature of tech stocks and the relatively high-interest-rate environment.

Stocks valued on high multiples of earnings, as the big tech stocks are valued, would conventionally be vulnerable to the substantial increases in US interest rates over the past two years, but the Magnificent Seven have defied convention.

That’s probably because they are highly cash-generative. Not only do their cash flows fund their operations and capital investment, but most of them have hefty cash reserves that benefit from higher interest rates. Apple, for instance, was holding $US73 billion ($110 billion) of cash and liquid assets at December 31.

A research paper issued by Goldman Sachs this week puts the Magnificent Seven’s dominance into perspective. It’s neither unique in today’s markets nor in history.

The 10 largest companies by value in the US market now account for more than 30 per cent of the S&P 500’s value, which Goldman says is the highest level since 1980.

While that might appear unusually concentrated, Goldman pointed out that the “Granolas” – the 11 biggest stocks in Europe (GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, L’Oreal and LVMH) – account for almost a quarter of the value of the 600 biggest companies in Europe and the top 30 companies in Japan hold a share of that market similar to that of the Magnificent Seven in the US.

The dominance of Apple and its tech peers have raised bubble concerns. Credit: Bloomberg

In Australia, of course, the market is dominated by the big four banks and Macquarie, along with BHP, Fortescue, CSL and Wesfarmers. The top 10 Australian stocks account for about 27 per cent of the ASX 200’s value.

Goldman Sachs said that while high market concentration might be a sign of a bubble, it doesn’t necessarily mean that there is one.

While the biggest stocks in the US market are much bigger as a share of the market than in the dot-com bubble of 2000, valuations today are much lower than in that episode, the “Nifty 50” era in the US or Japan’s bubble in the 1980s.

In terms of forward price-earnings multiples, the Magnificent Seven trade on about half the multiples of the seven biggest stocks ahead of the dot-com crash. They are far more profitable and have far stronger balance sheets.

The Goldman paper also discusses the dominance of the US market over the global equities market and, as with the increased concentration of the US market, says it isn’t unprecedented.

The US market, it says, has strongly outpaced other markets and has a global market share of 50 per cent, which is high by historical standards but not as high as it was in the 1970s, when Exxon, Mobil, the big US auto companies, General Electric and IBM were the US market’s heavyweights.

That share of global equities slumped to less than 30 per cent in the late 1980s when, at the peak of Japan’s sharemarket and economic bubble, Japan had the biggest market and the four biggest companies (all banks) and six of the top 10 in the world.

The US share of global equity markets has accelerated dramatically since the global financial crisis in 2008 and the value of the US market relative to US GDP has risen steadily, a trend not seen elsewhere, although Goldman suggests that part of the explanation may be that many non-US companies are now listed in the US.

The outperformance of the US market has been driven by fundamentals.

Earnings have grown faster than elsewhere and, as interest rates fell post-2008, that growth was more highly valued. Other factors Goldman cites are a higher reinvestment rate by US companies, the greater liquidity of the US market and the sheer size and strength of a US economy that has grown at a higher rate than the other major market economies.

The outsized performance of a particular sector, in this instance the mega techs, isn’t a unique phenomenon.

Over the past two centuries, Goldman says, the biggest industry in the stock market at each point in time reflected the major driver of economic growth. Finance and real estate dominated in the 19th century and transport in the 20th. The tech sector today is about the same size, relative to the market, as the energy sector was in the 1950s.

Considered within that perspective, it isn’t surprising that technology stocks dominate in a 21st century when technology is the driver of innovation and growth and in which the applications emerging in artificial intelligence – which have driven the most recent market gains – are expected to have profound implications for economies and societies.

For the sceptics, Goldman does provide some comfort in responding to whether the high levels of concentration in the market pose a big risk.

Historically, as it says, only 52 companies have appeared in the Fortune 500 since 1955 – only just over 10 per cent have remained on the list. Innovation, competition, misjudgements and anti-trust regulations are some of the factors in the high turnover at the big end of the corporate world.

Only half of the top 50 companies in the US were there a decade ago, with many of them not even existing before the 1990s.

Therefore, the current dominance of the Magnificent Seven may be prolonged but, if history is any guide, is most unlikely to be permanent.

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