The "Magnificent Seven" tech giants, including Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia, and Tesla, have achieved unparalleled market dominance, contributing to a 19% overall increase in the S&P 500 in 2023. Their collective market cap reached nearly $4 trillion, outpacing the gains of the entire MSCI All Country World index. While these companies boast a 71% return, concerns arise about elevated expectations and potential market concentration risks. Despite the technology sector's elevated valuations, the current P/E ratio of the top seven companies is notably lower than historical precedents, indicating a more robust financial position. As these tech giants continue to shape the market, caution is advised, considering potential risks and the evolving economic landscape in 2024.
Markets breakdown
Core CPI deceleration persists, as core inflation slows to 4.3% annually from July's 4.7%, despite a 0.3 percentage point increase. Monthly, used car prices drop 1.2%, tempering core goods inflation by 0.1%. Core services ease to a 5.9% annual pace, the slowest since July 2022, and shelter inflation decelerates for a fifth consecutive month to 7.2% year-on-year. Despite this, headline CPI rises to 3.7% year-on-year in August, driven by a 5.6% increase in energy prices, notably gasoline due to OPEC's oil supply cuts. The moderation in core goods and services supports an estimated 4.0% average headline inflation in 2023, cooling to a 2.5% average in 2024.
Recent signs of moderation in inflation and labor market data suggest the Fed has likely reached its terminal policy rate, but rate cuts aren't imminent given ongoing economic strength. Real GDP growth has exceeded its 1.9% potential trend since mid-2022, with Q3 2023 consensus estimates indicating continued growth. Despite potential downside risks such as autoworkers strikes (as we have seen in Detroit with the major automobile producers), a government shutdown, and student loan payment restarts, a significant growth slowdown is anticipated in 2024. This, coupled with cooling inflation, is expected to lower the 10-year US Treasury yield to 3.9% by year-end 2023 and 3.5% by year-end 2024.
The August 2023 jobs report reveals solid payroll growth, but revisions and a slowing three-month moving average indicate a loosening labor market. While the unemployment rate rises to 3.8%, it's attributed to a positive 736,000 labor supply increase. This larger labor pool exerts downward pressure on wage growth, dropping to 4.2% year-on-year in August. Vacancies decline to 8.8 million, the lowest since March 2021, signaling labor market cooling, while the quits rate falls to approximately its pre-pandemic rate of 2.4%. Initial jobless claims remain low, but continuing claims show a gradual uptrend in 2023.
Bank lending tightening hasn't stifled expansion, but weak business loan demand follows March's bank failures. Consumer spending, resilient to interest rate hikes, sees a 0.6% real increase in July. However, household balance sheets are expected to weaken as wage growth slows and interest costs rise. Savings rates fall to 3.5% in July, indicating continued spending out of savings. Business surveys reflect improved sentiment, with the ISM manufacturing index rebounding to 47.6 and the ISM services index rising to 54.5, its strongest level since February.
Amid the current interest rate environment, the 3-month Treasury bill offers a 5.5% yield, aligning with the University of Chicago's average yearly opinion of a 9% earnings yield on the S&P 500 index. This convergence suggests a discernible transition in risk preferences, with an increasing inclination toward bonds. This shift is notably pronounced as we approach a more uncertain macroeconomic landscape in 2024. Collectively, households, mutual funds, pension funds, and foreign investors currently hold a substantial allocation to stocks (48%), ranking at the 97th percentile historically. In contrast, bond (20%) and cash (14%) allocations stand at the 43rd and 23rd percentiles, respectively. Our projection anticipates that most of these ownership categories will be net sellers of stocks in 2024. Throughout 2023, money market mutual funds have attracted around $1.2 trillion in net inflows, whereas US stocks have seen only $17 billion in inflows. Forecasts indicate that net corporate buybacks, totaling $550 billion, will constitute the primary source of demand for shares.
Unpacking the unexpected growth, the market experienced in the spring following the events involving regional banks in the United States reveals that it is largely attributable to sectors such as consumer discretionary and services. Thanks to a select group of stocks that have consistently outperformed their benchmarks, these sectors have propped up the market.
Recent signs of moderation in inflation and labor market data suggest the Fed has likely reached its terminal policy rate, but rate cuts aren't imminent given ongoing economic strength. Real GDP growth has exceeded its 1.9% potential trend since mid-2022, with Q3 2023 consensus estimates indicating continued growth. Despite potential downside risks such as autoworkers strikes (as we have seen in Detroit with the major automobile producers), a government shutdown, and student loan payment restarts, a significant growth slowdown is anticipated in 2024. This, coupled with cooling inflation, is expected to lower the 10-year US Treasury yield to 3.9% by year-end 2023 and 3.5% by year-end 2024.
The August 2023 jobs report reveals solid payroll growth, but revisions and a slowing three-month moving average indicate a loosening labor market. While the unemployment rate rises to 3.8%, it's attributed to a positive 736,000 labor supply increase. This larger labor pool exerts downward pressure on wage growth, dropping to 4.2% year-on-year in August. Vacancies decline to 8.8 million, the lowest since March 2021, signaling labor market cooling, while the quits rate falls to approximately its pre-pandemic rate of 2.4%. Initial jobless claims remain low, but continuing claims show a gradual uptrend in 2023.
Bank lending tightening hasn't stifled expansion, but weak business loan demand follows March's bank failures. Consumer spending, resilient to interest rate hikes, sees a 0.6% real increase in July. However, household balance sheets are expected to weaken as wage growth slows and interest costs rise. Savings rates fall to 3.5% in July, indicating continued spending out of savings. Business surveys reflect improved sentiment, with the ISM manufacturing index rebounding to 47.6 and the ISM services index rising to 54.5, its strongest level since February.
Amid the current interest rate environment, the 3-month Treasury bill offers a 5.5% yield, aligning with the University of Chicago's average yearly opinion of a 9% earnings yield on the S&P 500 index. This convergence suggests a discernible transition in risk preferences, with an increasing inclination toward bonds. This shift is notably pronounced as we approach a more uncertain macroeconomic landscape in 2024. Collectively, households, mutual funds, pension funds, and foreign investors currently hold a substantial allocation to stocks (48%), ranking at the 97th percentile historically. In contrast, bond (20%) and cash (14%) allocations stand at the 43rd and 23rd percentiles, respectively. Our projection anticipates that most of these ownership categories will be net sellers of stocks in 2024. Throughout 2023, money market mutual funds have attracted around $1.2 trillion in net inflows, whereas US stocks have seen only $17 billion in inflows. Forecasts indicate that net corporate buybacks, totaling $550 billion, will constitute the primary source of demand for shares.
Unpacking the unexpected growth, the market experienced in the spring following the events involving regional banks in the United States reveals that it is largely attributable to sectors such as consumer discretionary and services. Thanks to a select group of stocks that have consistently outperformed their benchmarks, these sectors have propped up the market.
Magnificent 7 analysis
With a market overview bared in mind, it’s important to define the so-called Magnificent seven – Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia and Tesla – which are seven large U.S. technology companies that have boosted U.S. dominance in stock markets this year, driving all global stock gains. Contributing to this, the magnificent seven stocks in 2023 reached nearly $4 trillion in market cap, compared to $3.4 trillion in gains for the MSCI All Country World index as a whole. In addition, they added a total of 40 points to the index, which increased by 37 points overall. 2023 will be the eighth year in the past 10 years of increasing U.S. share of global market capitalization, barring a reversal of the trend. As of today, U.S. companies account for 61% of the $60 trillion MSCI Index as opposed to 10 years ago when they amounted to less than 50%.
Source: Bloomberg
These companies are all focused on secular technology growth trends such as artificial intelligence, cloud computing, online games, and cutting-edge hardware and software. Their success is largely related to investors' enthusiasm for the growth of these sectors and specifically
AI. Technology is often seen as a bet on growth, but it is clear that these mega-capitalization stocks are already generating large profits without a clear catalyst to turn the tide. Indeed, if technology stocks amounted to 17% of the S&P 500's EPS in 2022, Goldman Sachs analysts estimate that these will grow to 24% by 2025.Therefore, looking at the results to date, there seems to be no reason for large technology stocks to lose ground. Indeed, while it is true that some of them have been affected by the recent rise in Treasury bond yields, on average they have undoubtedly held up better than the market.
To prove even more the market trend toward this industry and toward artificial intelligence, investors said that in a stock sale they would value OpenAI, the private U.S. based group behind ChatGPT, at about $86 billion, three times what it was worth in April. As Franklin Templeton's Gokhman said, even if enthusiasm for artificial intelligence wanes, growth stocks – which are much more common in the United States – would benefit when interest rates start to fall. This is because, after a good start to the year, U.S. and global stock markets in general have been overwhelmed in recent months by concerns and uncertainties about interest rates and geopolitical risks. However, technology stocks in U.S. markets have held up better than the market, achieving gains that belied the predictions of investors who said that cheap valuations would help other markets around the world catch up with the United States. It is no secret that U.S. stocks are more expensive than the rest of the world. Data from JPMorgan Asset Management, show that the S&P 500 index is trading at about 18 times the value of expected earnings over the next 12 months, compared with 12 times for the MSCI all-country index, excluding U.S. stocks. However, as stated by Jurrien Timmer, director of global macro at Fidelity, "The valuation [of non-U.S. stocks] is very attractive ... but just because something is cheap doesn't mean it will outperform."
AI. Technology is often seen as a bet on growth, but it is clear that these mega-capitalization stocks are already generating large profits without a clear catalyst to turn the tide. Indeed, if technology stocks amounted to 17% of the S&P 500's EPS in 2022, Goldman Sachs analysts estimate that these will grow to 24% by 2025.Therefore, looking at the results to date, there seems to be no reason for large technology stocks to lose ground. Indeed, while it is true that some of them have been affected by the recent rise in Treasury bond yields, on average they have undoubtedly held up better than the market.
To prove even more the market trend toward this industry and toward artificial intelligence, investors said that in a stock sale they would value OpenAI, the private U.S. based group behind ChatGPT, at about $86 billion, three times what it was worth in April. As Franklin Templeton's Gokhman said, even if enthusiasm for artificial intelligence wanes, growth stocks – which are much more common in the United States – would benefit when interest rates start to fall. This is because, after a good start to the year, U.S. and global stock markets in general have been overwhelmed in recent months by concerns and uncertainties about interest rates and geopolitical risks. However, technology stocks in U.S. markets have held up better than the market, achieving gains that belied the predictions of investors who said that cheap valuations would help other markets around the world catch up with the United States. It is no secret that U.S. stocks are more expensive than the rest of the world. Data from JPMorgan Asset Management, show that the S&P 500 index is trading at about 18 times the value of expected earnings over the next 12 months, compared with 12 times for the MSCI all-country index, excluding U.S. stocks. However, as stated by Jurrien Timmer, director of global macro at Fidelity, "The valuation [of non-U.S. stocks] is very attractive ... but just because something is cheap doesn't mean it will outperform."
Source: J.P. Morgan AM
What about the future? While JPMorgan's asset management division emphasized its expectations for better returns from emerging and developed markets outside the United States, Luca Fina, head of equity at Generali Insurance Asset Management remarked on the position of the United States as an environment of innovation and creation of disruptive companies, which in the medium to long term will likely continue to be perceived as the place to be. Hence, visions in this regard appear to be contrasting, and it would be interesting to see the outcomes in the long run: will the U.S. equity markets remain consistently attractive globally, or will someone sooner or later close the gap?
In the recent landscape of the stock market, the influence of the "Magnificent Seven", namely Apple (AAPL), Alphabet (GOOGL, GOOG), Microsoft (MSFT), Amazon (AMZN), Meta (META), Tesla (TSLA), and Nvidia (NVDA), has reached unprecedented heights. As revealed in Goldman Sachs' 2024 US Equity Outlook, these seven companies now collectively represent a staggering 29% of the S&P 500's market capitalization.
The stellar performance of the seven stocks is characterized by returns soaring by an impressive 71% as opposed to a more modest 6% gain experienced by the remaining 493 stocks in the S&P 500. This dichotomy constituted a notable feature in the 2023 equity market and has played a pivotal role in propelling the S&P 500 to an overall 19% increase in returns over the course of the year.
Delving into essential metrics, the performance of the Magnificent Seven consistently stands out. Over the period from 2013 to 2019, their compound annual growth rate soared to 15%, a stark contrast to the 2% rate observed among the remaining stocks. Although this margin experienced a slight narrowing in the past two years, settling at 18% versus 15%, Goldman Sachs anticipates a substantial widening of this gap in the coming years. According to their projections, from 2023 to 2025, the Magnificent Seven are expected to grow at a robust rate of 11%, significantly surpassing the 3% growth anticipated for the rest of the S&P 500.
Additionally, the net profit margin of the seven tech giants stands at 19%, far exceeding the 9.8% achieved by other companies in the index. When it comes to the long-term earnings per share growth expectations, the Seven continue to shine, boasting a notable 17%, while the rest of the index lags at a comparatively modest 9%. This sustained outperformance across various financial indicators solidifies the Magnificent Seven's standing as not just market leaders but consistent drivers of growth and profitability.
David Kostin, Goldman's chief US equity strategist, attributes Magnificent Seven's outperformance to a rebound in margins and earnings which align with the consensus expectation that they will continue delivering faster growth. However, Kostin advises caution despite the foreseen upward trajectory for 2024 due to elevated expectations. The risk/reward profile for this trade is not especially attractive and the increased hedge fund ownership along with a potential shift in AI enthusiasm present two threats to the mega-cap tech stocks.
In the recent landscape of the stock market, the influence of the "Magnificent Seven", namely Apple (AAPL), Alphabet (GOOGL, GOOG), Microsoft (MSFT), Amazon (AMZN), Meta (META), Tesla (TSLA), and Nvidia (NVDA), has reached unprecedented heights. As revealed in Goldman Sachs' 2024 US Equity Outlook, these seven companies now collectively represent a staggering 29% of the S&P 500's market capitalization.
The stellar performance of the seven stocks is characterized by returns soaring by an impressive 71% as opposed to a more modest 6% gain experienced by the remaining 493 stocks in the S&P 500. This dichotomy constituted a notable feature in the 2023 equity market and has played a pivotal role in propelling the S&P 500 to an overall 19% increase in returns over the course of the year.
Delving into essential metrics, the performance of the Magnificent Seven consistently stands out. Over the period from 2013 to 2019, their compound annual growth rate soared to 15%, a stark contrast to the 2% rate observed among the remaining stocks. Although this margin experienced a slight narrowing in the past two years, settling at 18% versus 15%, Goldman Sachs anticipates a substantial widening of this gap in the coming years. According to their projections, from 2023 to 2025, the Magnificent Seven are expected to grow at a robust rate of 11%, significantly surpassing the 3% growth anticipated for the rest of the S&P 500.
Additionally, the net profit margin of the seven tech giants stands at 19%, far exceeding the 9.8% achieved by other companies in the index. When it comes to the long-term earnings per share growth expectations, the Seven continue to shine, boasting a notable 17%, while the rest of the index lags at a comparatively modest 9%. This sustained outperformance across various financial indicators solidifies the Magnificent Seven's standing as not just market leaders but consistent drivers of growth and profitability.
David Kostin, Goldman's chief US equity strategist, attributes Magnificent Seven's outperformance to a rebound in margins and earnings which align with the consensus expectation that they will continue delivering faster growth. However, Kostin advises caution despite the foreseen upward trajectory for 2024 due to elevated expectations. The risk/reward profile for this trade is not especially attractive and the increased hedge fund ownership along with a potential shift in AI enthusiasm present two threats to the mega-cap tech stocks.
Risk factors
As we have mentioned, much of the recent S&P500 growth has been driven by the Magnificent Seven. While investing in the broader U.S. market – a collection of companies based on size — seems like it should offer diversified and balanced exposure, it may actually introduce significant concentration risk to portfolios. Many investors look to top-heavy, growth-tilted indexes such as the S&P 500 primarily for exposure to the U.S. large-cap space. However, with cap-weighted indexes recently reaching record levels of concentration, it may be worthwhile to consider an alternative approach.
A multifactor ETF can offer more balanced exposure and help investors take “smarter” risk. In contrast to traditional benchmarks, a multifactor ETF is structured to target specific factors that enhance returns while reducing exposure to unnecessary risks.
The Hartford Multifactor US Equity ETF (ROUS) may be a viable solution for investors looking for more diversified exposure to the broader market. The fund is engineered to provide equity exposure with potentially lower volatility and risk compared to the traditional cap-weighted indexes.
It's worth noting that concentration risk prevails not only at the company level but also within sectors. Over-reliance on mega-cap companies leads to significant idiosyncratic risks, overshadowing other large-cap entities in the market universe.
Being overly concentrated at the company level introduces significant idiosyncratic company risk. There is an overrepresentation of megacaps, while persistently under-representing large-caps deeper within the universe.
At the sector level, overexposure to possible bubble events such as the AI rally poses timing challenges. In the current environment, the information technology sector comprises nearly half of cap-weighted S&P 500 funds by weight.
Furthermore, cap-weighted funds continue to allocate more assets to past top performers, disregarding current valuations. This results in significant portions of funds being invested in potentially overvalued stocks. Meaning, they’re potentially allocating a significant portion of a fund to overbought or overvalued stocks.
Finally, volatility risk is also a concern worthy of consideration when allocating to cap-weighted funds. Investing in funds that are not mindful of volatility when selecting securities introduces behavioral and capital growth challenges.
Some people worry about the risk of the AI rally being a bubble, but data does not show that yet. Valuations in the technology sector are undeniably elevated compared to historical standards, as per Goldman Sachs Research. The current price-to-earnings (P/E) ratio for the US technology sector is at its peak when measured against the 10-year median and range. However, this doesn't tell the whole story. The top seven US companies leading the charge in commercializing generative AI technology have an average P/E of 25, in contrast to a P/E of 52 for the largest companies during the peak of the internet bubble. In the late 1960s, the leading companies in the "Nifty 50" bubble had a P/E over 34.
The existing cohort of tech frontrunners is notably profitable and consistently generates cash, enabling substantial investments despite heightened interest rates and borrowing expenses. Their cash reserves, relative to market capitalization, stand at twice the proportion observed during the internet bubble era. Additionally, their return on equity and average margins nearly double those witnessed in the 1990s surge. Goldman Sachs analysts highlight that these dynamics have rendered these firms comparatively resilient regarding their revenues and earnings. Furthermore, these companies are fortifying their competitive advantages and significantly enhancing the outlook for future growth.
In summary, the "Magnificent Seven" tech giants wield unprecedented influence, accounting for nearly $4 trillion in market capitalization in 2023. Their exceptional performance, with returns soaring by 71%, contrasts sharply with the more modest gains of other S&P 500 stocks, propelling the index to a 19% overall increase.
Despite their dominance and robust growth projections, concerns loom around elevated expectations and potential market concentration risks, prompting a cautious eye on their trajectory amidst evolving market dynamics.
A multifactor ETF can offer more balanced exposure and help investors take “smarter” risk. In contrast to traditional benchmarks, a multifactor ETF is structured to target specific factors that enhance returns while reducing exposure to unnecessary risks.
The Hartford Multifactor US Equity ETF (ROUS) may be a viable solution for investors looking for more diversified exposure to the broader market. The fund is engineered to provide equity exposure with potentially lower volatility and risk compared to the traditional cap-weighted indexes.
It's worth noting that concentration risk prevails not only at the company level but also within sectors. Over-reliance on mega-cap companies leads to significant idiosyncratic risks, overshadowing other large-cap entities in the market universe.
Being overly concentrated at the company level introduces significant idiosyncratic company risk. There is an overrepresentation of megacaps, while persistently under-representing large-caps deeper within the universe.
At the sector level, overexposure to possible bubble events such as the AI rally poses timing challenges. In the current environment, the information technology sector comprises nearly half of cap-weighted S&P 500 funds by weight.
Furthermore, cap-weighted funds continue to allocate more assets to past top performers, disregarding current valuations. This results in significant portions of funds being invested in potentially overvalued stocks. Meaning, they’re potentially allocating a significant portion of a fund to overbought or overvalued stocks.
Finally, volatility risk is also a concern worthy of consideration when allocating to cap-weighted funds. Investing in funds that are not mindful of volatility when selecting securities introduces behavioral and capital growth challenges.
Some people worry about the risk of the AI rally being a bubble, but data does not show that yet. Valuations in the technology sector are undeniably elevated compared to historical standards, as per Goldman Sachs Research. The current price-to-earnings (P/E) ratio for the US technology sector is at its peak when measured against the 10-year median and range. However, this doesn't tell the whole story. The top seven US companies leading the charge in commercializing generative AI technology have an average P/E of 25, in contrast to a P/E of 52 for the largest companies during the peak of the internet bubble. In the late 1960s, the leading companies in the "Nifty 50" bubble had a P/E over 34.
The existing cohort of tech frontrunners is notably profitable and consistently generates cash, enabling substantial investments despite heightened interest rates and borrowing expenses. Their cash reserves, relative to market capitalization, stand at twice the proportion observed during the internet bubble era. Additionally, their return on equity and average margins nearly double those witnessed in the 1990s surge. Goldman Sachs analysts highlight that these dynamics have rendered these firms comparatively resilient regarding their revenues and earnings. Furthermore, these companies are fortifying their competitive advantages and significantly enhancing the outlook for future growth.
In summary, the "Magnificent Seven" tech giants wield unprecedented influence, accounting for nearly $4 trillion in market capitalization in 2023. Their exceptional performance, with returns soaring by 71%, contrasts sharply with the more modest gains of other S&P 500 stocks, propelling the index to a 19% overall increase.
Despite their dominance and robust growth projections, concerns loom around elevated expectations and potential market concentration risks, prompting a cautious eye on their trajectory amidst evolving market dynamics.
By Giorgio Gusella, Federica Guirguis, Anna Rosaria Manni, Enrico Dametto
SOURCES:
- Bloomberg
- Goldman Sachs
- J.P. Morgan Asset Management
- University of Chicago
- OPEC
- Financial Times 3
- Specific Companies' Reports**