The Magnificent Seven

Monthly Outlook: July 2023

Some of our readers will remember a great American Western movie from the 1960s called The Magnificent Seven. It had a great cast with Steve McQueen, Yul Brynner, Charles Bronson, and others as tough guys that were hired to save the town. Today, there’s a new Magnificent Seven in town and they’re here to save the stock market. Apple, Microsoft, Amazon, Nvidia, Google, Tesla, and Meta (Facebook). These seven stocks have rallied for the past six months as investors are in love with anything “AI” or involved with artificial intelligence. AI is the new “dot com” and investors will pay any price to be a part of it. Maybe we should change our investment strategy name from i-Folios to AI-Folios!

7 vs 493

The Magnificent Seven stocks have provided nearly all of the returns of the S&P500 this year. This contribution is due to two factors: 1) these seven companies are huge and 2) they’ve gained +40% to 100%-plus in just six months. Benchmark indexes like the S&P500 are weighted by market capitalization (market cap), which is simply the number of shares multiplied by the price. Apple, for example, has the largest market cap in the market at nearly $3 trillion dollars and makes up 7.6% of the entire S&P500. In fact, the Magnificent Seven are the biggest seven companies (by market cap) and add up to 27.3% of the S&P500. We’ve never before seen such concentration in one industry (Tech & Internet) and in just seven stocks. To put Apple’s size into perspective, consider that it is as large as all of the 2000 companies in the small-cap Russell 2000 combined.

The overall S&P500 has had a solid year, gaining about 14% so far. After all, the Magnificent Seven are 27% of the whole index. But without the contribution from the Magnificent Seven, the S&P500 would only be flat to slightly up. In fact, 25% of the S&P500 are in downtrends: Energy, Financials, Real Estate, and Utilities. Plus, Healthcare and Staples are close, which would be another 22% of the S&P500 downtrending. We’ve seen a few commentators using the “Market Has Bad Breadth” headline and it’s so true. It’s rare for such a few, huge, companies to dominate the market performance.  That said, I should point out that in 2022, the Energy sector gained 61% while Technology lost 24%. But Energy is only 5% of the S&P500 and no one is ever too excited to put all of their portfolio in Energy stocks. Technology is exciting, it’s dominated by a few mega-companies, and it makes headlines. Investors tend to chase tech stock performance.

S&P500 vs NASDAQ vs The Dow

Investors and media often talk about how “the market” is performing. But what market, exactly, are they talking about? It matters because the three most common benchmarks are very different. The S&P500 is a diversified basket of 500 of the largest companies. It is market-cap weighted, so size matters. It has about 28% technology, 14% Healthcare, 11% Consumer Discretionary, 12% Financials, and so on—I would suggest it is “the market.” The NASDAQ 100, also market-cap weighted, is practically a technology fund. Those Magnificent Seven stocks comprise 55% of the whole NASDAQ 100 index, for example. I would dare say that the NASDAQ is not “the market” but rather a specialty sub-set. The Dow, or Dow Jones Industrial Average, is a price-weighted list of just 30 stocks. All 30 are also in the S&P500. It’s an odd short-list of stocks and considered somewhat antiquated. I’d recommend investors ignore it.

What Will Next 6 Months Bring?

Reversion to the mean is one of the strongest factors in investing. Yes, the Magnificent Seven have been stellar and yes, they continue to trend higher for now. We wouldn’t recommend selling them. But just as these seven stocks did great while the S&P500 languished, it’s also possible that the Big Tech stocks correct a bit while the strength broadens out into other sectors of the market. Our plan is to stay globally diversified, across all sectors, and across all market-cap size categories. That is, as long as that asset class or ETF is trending higher. We’d also point out that bonds, even long-term bonds, have started to trend higher and we’re buying bond ETFs. The Magnificent Seven have been absolutely, well, magnificent, but we wouldn’t be surprised if other markets do better soon. After all, even in the 1960s movie, not all of the gunmen fared too well in the end.