The Magnificent Seven: Unstoppable Tech Giants or Risky Investments?

Did you know that the phrase "Magnificent Seven" was actually coined as a warning rather than a compliment? This term has been used to describe a select group of dominant tech stocks in the market. In this article, we will explore both the risks and rewards associated with owning these powerful stocks.

Most investors are familiar with the group known as the "Magnificent Seven." However, it's important to recognize that this name was more of a cautionary tale than a praise. Bank of America executive Michael Hartnett has highlighted several potential downsides associated with these stocks over the years.

Defining the Magnificent Seven Stocks

The seven stocks in question have had a significant impact on the value of the S&P 500 index in recent years. The seven companies that dominate this group are:

• Microsoft (MSFT)
• Amazon (AMZN)
• Meta Platforms (META)
• Alphabet (GOOGL)

In addition to these software powerhouses, three hardware leaders make up the rest of the group:

• Apple (AAPL)
• Nvidia (NVDA)
• Tesla (TSLA)

This combination of AI experts and electric vehicle pioneers has been instrumental in shaping the stock market landscape.

As of late 2024, these seven companies remain at the forefront of the market. They were among the largest stocks by market cap in early 2023 and have grown even more dominant since then. Remarkably, only two of them—Microsoft and Apple—have not outperformed the S&P 500 index since May of last year, while the others have seen substantial increases, driving the index upward.

The Risks Within This Group

Reflecting on the concerns raised in May 2023, Hartnett pointed out multiple risks associated with the Magnificent Seven stocks:

• The expectation of rising federal funds interest rates, which were projected to exceed 4% (up from 0.8% at the time). The actual rate later climbed to 5.3% within three months.
• The group accounted for nearly all the gains in leading market indexes early in 2023. While stocks like Nvidia and Meta flourished, nearly half of the S&P 500 stocks lost value during the same period.
• Given their size, these stocks have a disproportionate influence on market capitalization-weighted indexes such as the S&P 500 and Nasdaq Composite. The Magnificent Seven now represents 32.2% of the S&P 500 index, a significant increase from 27.3% in May 2023 and 20.1% at the end of 2022. Hartnett sees potential risks stemming from this concentration.
• Hartnett also suggested that there might have been a "baby bubble" surrounding AI at that time. It is now recognized as either a genuine macro trend or potentially one of the largest market bubbles ever.

Michael Hartnett identified this important group early on and aptly named it, drawing inspiration from a classic Western film known for its tragic ending. He could have chosen a more optimistic term, but he selected a title that alluded to caution.

In the iconic movie, only three of the original seven gunfighters survive. This metaphor serves as a reminder to investors: while the current outlook for these tech giants appears positive, it’s crucial to remain vigilant about inflated valuations in this market.

Strategies to Manage Investments in the Magnificent Seven

Presently, the average valuation for S&P 500 stocks stands at 28.7 times price-to-earnings (P/E) and 23.6 times price-to-cash reserves (P/C). Here’s how the Magnificent Seven stocks stack up:

Magnificent Seven Stock	P/E Ratio	P/C Ratio	Market Cap
Alphabet	23.7	23.2	$2.16 trillion
Meta Platforms	27.8	28.4	$1.48 trillion
Tesla	88.0	32.7	$1.11 trillion
Nvidia	69.3	103.2	$3.59 trillion

Data is sourced as of November 9, 2024. P/E Ratio represents price-to-earnings ratio, while P/C Ratio indicates price-to-cash ratio.

The reliance of market indicators on these seven companies is significant, and it continues to grow. A setback for a major player like Nvidia or Microsoft could impact the entire stock market, which is the concern Hartnett warned about to his clients 18 months ago.

Investors are advised to select their investments with caution, even within booming fields like AI and electric vehicles. Diversifying your portfolio can help withstand market downturns and foster long-term wealth building. This was the essence of Hartnett's message with his "Magnificent Seven" metaphor: while these impressive giants may currently shine, they could pose risks to your portfolio in the future.

Stocks, Investments, Risks