Over the course of 2023, seven of the largest stocks in the United States collectively doubled in value, earning the moniker, “the Magnificent 7.” After such impressive performance, what comes next?
The rally in these stocks had strong fundamental underpinnings. For example, on average, these companies increased profit margins by 21% from their pre-covid levels. At the same time, balance sheets strengthened even as capital spending increased, allowing these companies’ managements to reinvest in their businesses.
In addition to improved balance sheets, optimism around the long-term growth prospects for the Magnificent 7 – also called the Mag 7 – companies grew, in part because of artificial intelligence. With the release of AI-driven Bard and shortly after Chat GPT-4, many in the global public were able to interact with artificial intelligence for the first time. With that, earnings expectations grew substantially for companies such as Nvidia, Microsoft and Apple.
S&P 500 vs the Magnificent 7: 2023 Performance
NOTE: Values are indexed to 100. Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Note: views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. Source: Kestra Investment Management with data from FactSet. Index proxies: S&P 500, and The Magnificent 7 (Apple, Amazon, Alphabet, Microsoft, Meta, Nvidia and Tesla). Data as of December 29, 2023.
While earnings certainly increased, so too did valuations. On average, the Magnificent 7 are currently trading at around 30x expected earnings over the next 12 months, roughly 11% higher than the technology sector as a whole and 58% higher than the sector’s 10-year average. Higher valuations make these stocks more vulnerable should earnings disappoint.
It’s also helpful to remember that as recently as 2022, the Magnificent 7 didn’t seem so magnificent. In fact, in that year, those seven names lost nearly half of their collective value, a much steeper drop than the S&P 500, which lost 18% of its value.
S&P 500 vs the Magnificent 7: 2022-2023 Performance
NOTE: Values are indexed to 100. Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Source: Kestra Investment Management with data from FactSet. Index proxies: S&P 500 and the Magnificent 7 (Apple, Amazon, Alphabet, Microsoft, Meta, Nvidia and Tesla). Data as of December 29, 2023.
The extraordinary outperformance of technology shares and the ensuing excitement around artificial intelligence also means that other areas of the market may have been overlooked. For example, the Russell 2000, made up of smaller capitalization stocks, is still 17% below its all-time high in 2021. A softening interest rate environment combined with improved real GDP growth has historically boded well for small-cap names and other risk assets.
A properly diversified portfolio, with exposure to both AI-related stocks and smaller-cap ones, allows investors to capitalize on innovation, while also providing a buffer against sharp market declines.
Until next time, invest wisely, and live richly,
Kara
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Investment Services, LLC, and Bluespring Wealth Partners, LLC. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by any entity for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Investment Services, LLC, and Bluespring Wealth Partners, LLC does not offer tax or legal advice.
