This week, while engaged in my usual market analysis and occasional punditry, I noticed an interesting phenomenon: all of the so-called “Magnificent Seven” stocks were trading together each day. On Monday, they were all higher; on Tuesday, all lower; yesterday, all higher. And as I type this, six of the seven are lower, with only Nvidia (NVDA) hanging onto a modest gain. After some analysis, it turns out that this is a relatively frequent occurrence – and one that has become more frequent in recent weeks.
Through yesterday, six or seven of those stocks moved up or down together about 55% of the time this year (109 of 198). Even since late May, when the term “Magnificent Seven” joined the market parlance, that ratio has remained relatively constant at 54% (52 of 96). Yet the intraday correlation has increased recently. Whether measuring from the end of July – chosen because the S&P 500 (SPX) has yet to exceed its July 31st close – or the start of September, the ratio has risen to 62.5% (30 of 48, 15 of 24).
It seems apparent that these seven mega-cap stocks trade as though they are a sector. But what sector would that be? Of course, they are all technology companies to some degree, and many of them have overlapping business interests, but tech investors typically divide that broad industry group into smaller sub-sectors (e.g. semiconductors, hardware, software, etc.). One could potentially assert that all benefit from some exposure to this year’s hottest theme in investing — artificial intelligence (AI) – but that seems like an inadequate explanation for their continuing market dominance.
The most similar characteristic of these stocks is their dominant market power in key areas of tech. All have significant competitive moats around key elements of their businesses that would be phenomenally expensive, if not impossible, to breach.
Certainly if we think about search, Alphabet (GOOG, GOOGL) and to a lesser extent Microsoft (MSFT) have that covered. Operating systems for personal computing is a basically a two-way choice between MSFT and Apple (AAPL). For cell phone operating systems, it’s AAPL and GOOG. For cloud computing, the three largest players are GOOG, MSFT and Amazon (AMZN). Of course Meta Platforms (META) and Tesla (TSLA) have significant advantages in social media and electric vehicles, respectively, and NVDA is perceived as a clear leader in the chips that power AI.
Those competitive advantages[i] are the key to the premium valuations placed upon these stocks. Earlier this week we acknowledged that the seven sport forward price-earnings (P/E) ratios nearly double that of the other 493 stocks in SPX. At the time we attributed it simply to earnings growth, writing:
“Those statistics tell me that investors are still paying a significant premium for the growth they anticipate from these mega-cap tech companies.”
Yet as I think about it today, that statement seems accurate but insufficient. I now believe that the premium valuations sported by these stocks can be attributed equally, if not more so, to their business’ dominance.
The idea of paying for dominance can also explain why these stocks tend to move in tandem more often than not. The ups and downs of the “Magnificent Seven” sector can be traced more to investors’ relative willingness or unwillingness to pay a premium for dominance rather than the vagaries of the specific companies on a particular day. And because these companies dominate the most visible market capitalization weighted indices – they are over 25% of SPX and about 43% of the NASDAQ 100 (NDX) – as these stocks move, so go the indices. Or vice versa. If the broad market moves up or down, so go these stocks. The former effect is why we highlighted a sea change in sentiment toward these seven companies as a potential “pain trade.”
The other factor that nags at me is that throughout history, seemingly unassailable groups of stocks have a way of stumbling nonetheless. Think about the key internet leaders in 1999-2000. Or go back further in history to the “one-decision stocks” and “Nifty Fifty” stocks[ii] of the1960’s and ‘70’s. Many of those stocks, like IBM, Xerox (XRX), Eastman Kodak, Polaroid, and J.C. Penney had seemingly unassailable advantages as well. I don’t predict a similar imminent fate for the market’s current leaders, but it can be a correlated, nasty event if investor sentiment towards these stocks reverses even somewhat.
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[i] Or anti-competitive practices as the US Justice Department alleges about Alphabet and the Federal Trade Commission and 17 states allege about AMZN and the UK antitrust authorities are investigating about MSFT and AMZN.
[ii] Not to be confused with India’s current benchmark Nifty 50 Index
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Consider that what you refer to as the “broad market” is not so broad. Cap weighted S&P00 for example is heavily concentrated in a very few companies.
Astute observation. Thanks
Thanks for engaging!