An electronic board displays the chart of daily share price movement on the Tokyo Stock Exchange along a street in Tokyo on February 8. Gains in tech shares have contributed to a surge in stock markets around the world, driven largely by the influence of the “Magnificent Seven” group of large tech firms. Photo: AFP
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Why Magnificent Seven US tech stocks are the bubble that won’t burst
The Magnificent Seven’s dominance of US stocks and its outsize impact on the performance of global equity markets has amplified fears of a new tech bubble
These fears ignore that the grouping is built on sound fundamentals and is driving structural mega trends rather than being a threat to financial stability
In stock markets, records are close to being surpassed around the world. The Nikkei 225 index, one of Japan’s main equity gauges, surged past the all-time high it set in December 1989 even though Asia’s second-largest economy unexpectedly slipped into recession last quarter.
Last week, the French and German stock markets reached a record high despite a bleak economic outlook for the euro zone. The MSCI World Index, a gauge of shares in advanced economies, also hit a new peak, having surged 20 per cent since the end of October. The rally was driven by the strong gains in stocks in the United States, which has a 70 per cent weighting in the index.
A clutch of giant technology companies – Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla – has turbocharged the US equity market. So much so that if not for the “Magnificent Seven”, the benchmark S&P 500 index’s 26 per cent return last year would have been less than 10 per cent, according to data from S&P Global.
It is hard to overstate the importance of this septet. With the exception of Tesla, all the companies figure among the world’s top seven firms by market capitalisation. Moreover, the group’s combined weighting in the S&P 500 is 29 per cent while its share of expected earnings growth this year is 34 per cent, according to JPMorgan.
Indeed, the Magnificent Seven are “more like countries than companies in size and profitability”, with the group’s combined market value of US$13.1 trillion double that of Japan’s equity market and its profits during the last 12 months roughly half of those generated by Chinese stocks, according to data from Deutsche Bank.
The Magnificent Seven’s dominance of US stocks and its outsize impact on the performance of global equity markets has amplified concentration risks and fanned fears about a dangerous bubble in the making.
A Microsoft logo is seen on an office building in midtown Atlanta, Georgia, on February 21. Microsoft is the largest company in the world by market capitalisation, and together with six other tech giants command a market value double that of Japan’s equity market. Photo: EPA-EFE
Bank of America notes that the staggering 140 per cent rise in the grouping since December 2022 is approaching the trough-to-peak gains of some earlier bubbles, notably the “Nifty Fifty” boom in US shares in the late 1960s and early ’70s and Japanese stocks’ epic rally in the late 1980s.
The stakes are highest for Nvidia, the semiconductor firm that controls more than 80 per cent of the market in specialist artificial intelligence (AI) chips and has contributed more than any other stock to the fierce rally in US equities. Its share price is up a dizzying 360 per cent since the start of 2023 while its trailing price-to-earnings ratio is just under 90, compared with 27 for the S&P 500. Expectations for future growth in revenues are sky-high.
Chameleon Global Capital Management, a hedge fund, points to a troubling disconnect between overwhelmingly bullish sentiment and a dispassionate analysis of Nvidia’s discounted cash flow, which “nobody really cares about” in a raging bull market that is “arguably in the ‘tulip phase’ where anything can happen”.
There are undeniable risks. The hype around AI – one of the main reasons many equity markets have been on a tear – could die down. More importantly, competition to develop new chips tailored for AI applications is bound to intensify.
There are also regulatory threats. The Magnificent Seven are in the firing line as politicians and regulators come under pressure to regulate Big Tech platforms and crack down on anticompetitive behaviour.
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Apple supplier Foxconn to build ‘AI factories’ using US hardware leader Nvidia’s chips and software
Apple supplier Foxconn to build ‘AI factories’ using US hardware leader Nvidia’s chips and software
The findings of Bank of America’s latest monthly global fund manager survey revealed that a long, or overweight, position in the Magnificent Seven was far and away the most crowded trade in markets, fuelled by expectations that interest rates will come down this year. Many things have to go right for the group’s spectacular outperformance to continue.
However, fears of another tech crash are overdone. For starters, today’s boom is a far cry from the run-up to the bursting of the dotcom bubble in 2000, when many profitless companies without sound business plans went down in flames. The Magnificent Seven, by contrast, are hugely profitable, have exceptional global reach and dominate tech innovation.
Moreover, while there are concerns about the group’s lofty valuations, Goldman Sachs notes that returns are being driven more by earnings growth. The Magnificent Seven were able to outperform in a high interest rate environment “in large part because of their strong balance sheets and elevated margins,” Goldman Sachs said.
If anything, the seven mega-cap growth stocks – with the exception of Tesla, whose share price has been more volatile – are something of a safe haven in a highly uncertain and unpredictable global economy. Many investors view the septet as defensive and resilient companies that can withstand a downturn.
A chart titled “Price Impact of Musk Tweets” is taken out of court in San Francisco on February 3, 2023. Investors suing Tesla and its CEO Elon Musk argued his August 2018 tweets about taking Tesla private with “funding secured” were “indisputably false” and cost them billions of dollars by spurring wild swings in Tesla’s stock price. Photo: Bloomberg
If there is a bubble in markets, it is in complacency. Investors still expect the US Federal Reserve to cut rates this year even though some measures of inflation are reaccelerating, the labour market remains tight and the stock market is booming. Why would the Fed cut rates sharply in such an environment?
More worryingly, judging by the record highs in equities and subdued levels of volatility, one would never think the US is holding a momentous presidential election in nine months. Regardless of the outcome – which might not be clear for quite some time after the vote – there is little upside for markets and plenty of downside, making the election one of the biggest underappreciated risks.
Not all bubbles burst, especially booms backed by strong fundamentals. The Magnificent Seven are a driving force behind structural mega trends rather than a threat to financial stability. Investor complacency is the biggest risk to asset prices.
