This article was taken from the December 2023 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications
Had we started 2023 with the foresight of further interest rate increases, conflict outbreaks, and banking industry wobbles, predicting a near 20% return for the US stock market via the S&P 500 would have resulted in a few raised eyebrows. Rather astonishingly, this is the position we find ourselves in, with nearly all the index’s returns generated by a small cohort dubbed ‘The Magnificent Seven.’ Names within this exclusive club include Apple, Amazon, Alphabet, Meta, Microsoft, NVIDIA, and Tesla.
This group of high-profile stocks dominated both headlines and attribution tables in 2023. In its 2024 US Equity Outlook, released in mid-November, Goldman Sachs’ strategists highlighted the scale of performance with the group, returning 71% in 2023, while the other four hundred and ninety-three names in the S&P 500 index rose just 6%. The report also highlighted the meaningful underperformance of the cohort in 2022, declining 39% against the -11% return of the remaining names in the index, indicating a share price reversal as a contributing factor. While the group’s returns are impressive, the spread within is wide. NVIDIA leads the bunch with 2023 returns to the end of November of 220.2% and a five-year figure of 1,053.6%. Amazon lagged with 73.9% and 72.9% over the same time periods, while the S&P 500 posted figures of 19.0% and 65.5%.
Most of the seven are expected to be household names, but NVIDIA is one which may not be initially recognised. A pioneer of Graphics Processing Units (GPU), a specialised computer chip, the company has arguably been the greatest beneficiary of the Artificial Intelligence (AI) uplift. It is not just hype behind NVIDIA, fundamentals are supporting the share price performance with net income expected to reach $27.6bn in the current financial year from the $4.4bn reported in the last financial year. AI is a consistent theme behind the Magnificent Seven’s performance with both Amazon and Microsoft benefitting from cloud computing, while Meta and Alphabet are profiting from returning advertising revenue and cost control.
The returns from these seven companies this year have caused concern for some regarding their 29% collective weighting at the top of the S&P 500, the highest concentration seen in the index’s history. This effect is even more pronounced in the technology-focused NASDAQ 100 Index, where the seven names account for almost 46% of the index. July saw NASDAQ make moves with a special rebalance to address overconcentration in the index by redistributing the holding weights. This concern is starting to feed through, with high profile names in the industry trimming US exposure for other developed and emerging markets.
Concerns around concentrated positions in a handful of names is understandable given the rise in index-based investment and potential for significant asset flows to push prices further with positive sentiment or create a forced selling effect in a drawdown. While conscious of this risk, expectations are positive for the ‘Magnificent Seven.’ For NVIDIA, 94% of covering analysts hold a ‘buy’ rating with an implied upside of 43% given the expectation for a long-term growth rate of 40.2%. Trading on 38x next year’s earnings, the valuation is not excessive but with expectations so high, even a slight miss at the next reporting date in February could see the share price head lower. For the other six names, implied upsides are more muted with analysts predicting returns in the 0-20% range.
The Magnificent Seven have produced impressive returns in 2023 thus far and looking forward, a repeat performance feels unlikely given the positive market sentiment which surrounded the constituents of the group and the AI trend generally. Despite this, the tailwinds remain positive, but the question remains as to whether outcomes will match expectations for a handful of names which now comprise a high weighting in the US flagship equity index.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.