Magnificent Seven: Unstoppable Tech Giants or Risky Investments?

Did you know the "Magnificent Seven" name was originally intended as a warning, rather than a praise? It sheds light on the potential risks and rewards of investing in these major tech stocks.

Most investors are familiar with the "Magnificent Seven" stocks, but few realize that this label was more cautionary than flattering. This warning, emphasized by Bank of America executive Michael Hartnett, has become increasingly relevant in today's market.

Understanding the Magnificent Seven Stocks

This group consists of tech giants that have significantly influenced the S&P 500 index over the past two years. To help remember them, I created a simple mnemonic: "MAMA ANT." While it didn't gain widespread popularity, it works for me. It includes the four software companies:

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

And the three hardware companies:

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

These major players, especially in artificial intelligence (AI) and electric vehicles, are shaping market trends today.

Looking ahead to November 2024, these seven companies continue to dominate the market. They were among the top ten largest U.S. stocks by market capitalization in spring 2023 and now hold the top seven positions. Only two of the Magnificent Seven—Microsoft and Apple—have underperformed relative to the S&P 500 since May of the previous year. The others have seen remarkable gains, lifting the overall index.

What Risks Come with These Market Leaders?

Referring back to Hartnett’s observations from May 2023, it’s crucial to consider the risks associated with these tech giants:

• Hartnett predicted that the federal funds interest rate would rise above 4% (up from 0.8% at the time) during the course of last year’s efforts to combat inflation. Ultimately, the rate escalated to 5.3% just a few months later.
• This group of tech giants contributed nearly all significant gains in the early 2023 market. At that time, nearly half of S&P 500 stocks were losing ground while Nivida and Meta Platforms enjoyed substantial upward movements.
• The collective size of these stocks means they hold disproportionate sway over market-weighted indices, such as the S&P 500 and the Nasdaq Composite. The Magnificent Seven now makes up 32.2% of the S&P 500's value, up from 27.3% in May 2023 and 20.1% by the end of 2022. This concentration raises concerns about market risks driven by a narrow set of stocks.
• Hartnett previously noted a potential "baby bubble" surrounding AI. If this forecast faltered, it would likely be in underestimating the significance of AI. The status of this technology is now anything but trivial.

Michael Hartnett's catchy title caught attention early and could have been labeled with various alternative titles. However, he chose a reference to a classic Western that culminates in tragedy. Other potential names might include "seven deadly sins" or "seven plagues," indicating risks rather than wonders.

In the classic film, only three of the original seven gunfighters survive the final showdown. This serves as a metaphor Hartnett used—while it does not imply the leading AI stocks are on the brink of failure, investors must pay close attention to inflated valuations in the market.

This classification should be taken as a warning, not as an endorsement for investment.

How to Approach the Magnificent Seven Today

The average S&P 500 stock trades at a price-to-earnings (P/E) ratio of 28.7 and a price-to-cash ratio of 23.6. Notably, Alphabet and Meta Platforms appear to be relatively affordable within this elite group, while Tesla and Nvidia seem rather overvalued:

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 from Finviz.com as of November 9, 2024.

Importantly, market indicators increasingly rely on these seven companies. Any unexpected difficulties faced by giants like Nvidia or Microsoft could impact the entire stock market. This scenario reflects the concerns Hartnett warned about 18 months ago.

Investors should be thoughtful when selecting stocks, especially in evolving sectors such as AI and electric vehicles. Diversification remains essential to navigate market downturns and foster long-term wealth. This is the crux of Hartnett’s warning with the Magnificent Seven—while these dominant companies appeared appealing in spring 2023 (and still do), they could pose risks to your portfolio down the line.

tech, stocks, investment