Interactive Investor

Magnificent Seven: time to take profits? Here’s what the pros think

America’s top tech stocks soared in 2023, but some investors are questioning whether their run can continue this year.

15th January 2024 11:22

by Sam Benstead from interactive investor

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Just seven companies accounted for around two-thirds of the S&P 500’s 24% gain in 2023, as big tech led the market due to advances in artificial intelligence (AI) and expectations that interest rates had peaked.  

The so-called Magnificent Seven counts Amazon, Apple, Tesla, Alphabet, Microsoft, Nvidia and Meta as members, with those shares soaring between 50% (Apple) and 240% (Nvidia) in 2023. 

But rising share prices have brought more expensive valuations relative to profits. The average price-to-earnings ratio for the next 12 months of profits for the group is now 44x, which is more than double the average of the S&P 500 index.  

With these shares now accounting for around one-third of the S&P 500 index of America’s largest companies, we assess what’s next after a very strong past 12 months.  

Can the AI boom continue?  

The driving force behind the recent returns from the Magnificent Seven has been the boom in AI, with the rise of “large language models”, or LLMs, driving much of the excitement.  

The most famous LLM is OpenAI’s ChatGPT, whose technology is being embedded by Microsoft in its products, and can be used to assist with writing, computer coding and image generation.  

AI models are being developed and deployed by all the Magnificent Seven, apart from Nvidia, which sells the computer chips that the models run on. 

The stage is set for transformative changes in how the world works and conducts scientific research, but has the hype got ahead of itself?  

Ben Rogoff, manager of Polar Capital Technology (LSE:PCT) Trust, says he is more excited than ever about the potential for AI and that we are at a “unique” moment in the history of technology innovation. 

He says: “A year after the launch of ChatGPT, the pace of current AI innovation is incredible, and we feel more excited than ever about further continued progress in AI. In our view, we are at a unique moment in the evolution of the technology landscape, with generative AI as important, if not more, than the internet and the smartphone.” 

Furthermore, he says that the “diffusion rate”, which is how long it takes for the technology to become widely adopted, is likely to be far quicker than either of those earlier general purpose technologies as the latest AI tools are being released to billions of global users instantaneously. 

While 2023 was about technological breakthroughs, as well as spending on computer chips which could see Nvidia’s annual revenue more than double in 2024 compared with 2023, the next 12 months could be marked by AI adoption and further technology breakthroughs.  

If, as Rogoff argues, this is the beginning of a new era of technology, then the AI investment theme has much further to run and the Magnificent Seven shares are likely to be at the centre of it.  

semiconductor chip

Have shares become too expensive? 

But while AI developments from this group of companies could lead to greater profits and revenue generation, there is still a danger that investors today are overpaying for shares.  

In fact, Rogoff says that given the strong run in 2023, it would not be surprising to see a near-term pullback in prices, especially as investor sentiment has turned more positive. Rogoff argues that over the short term there could be some profit-taking at AI-related companies and the Magnificent Seven. 

Indeed, 2024 has begun that way. The Nasdaq 100 index, a proxy for large US tech shares, dropped 2% in the first trading week of the year but has since recovered. 

On the other hand, the index only reached a new all-time high in December 2023, as it lost around one-third of its value in 2022. 

Rogoff says: “While Magnificent Seven returns have been exceptional, this in part reflects a very depressed starting point following exceptionally poor performance in 2022 when the group fell around 40%.” 

However, his view is that the returns of the Magnificent Seven in 2023 will not be repeated, and there will a “broadening out” of the winners from AI. 

“Although we expect robust growth from mega-cap technology stocks, we do not believe a repeat of ‘magnificent’ performance is likely with returns more in line with hopefully strong underlying growth. Instead, we expect a broadening of technology stock leadership as it becomes clear AI is benefiting more companies,” he said.  

Bank of America analysts also believe that more of the index returns will begin to come from companies outside the Magnificent Seven and there is a risk of overexcitement around Big Tech. 

“Some of this theme has played out: the equal-weighted S&P 500 has handily outperformed the market cap-weighted index since mid-November. We hear from our clients that a broadening of market leadership is now as consensus as the unwavering bond love/equity hatred we heard at the end of 2022. The January pain trade may thus be higher mega-caps,” its analyst said.  

The counterpoint, the bank adds, is that the continued boom in passive investing pushes more money into larger companies, “feeding growth” for giant firms and the Magnificent Seven. 

Another negative voice on the Magnificent Seven comes via UK fund managers at Schroders, where fund managers Alex Tedder and Tom Wilson says it is “time to do the opposite of what you did in the last decade”. 

They argue that over the past decade, all investors had to do was buy equities and invest for growth. 

But now they say a “reset” is under way and due to greater returns on cash, a new investor toolkit should include more diversification across regions, such as fewer US shares and more from the rest of the world, and a renewed attention to valuation, quality and risk. 

“On the basis of the above it is likely that the S&P will continue to trade at a premium to other markets. However, it is notable that the valuation gap between the US and the rest of the world is now at extreme levels.  

“To put this into context, the market capitalisation of the ‘Super-7’ group (responsible for most of the return from global equities in 2023) is now greater than that of the UK, France, China and Japan combined. Historically, while such polarisation has often persisted for long periods, inevitably at some point the gap closes,” the fund managers said.  

How to invest to back or avoid the Magnificent Seven 

Investors worried about a fall for the Magnificent Seven could look at funds that own small and mid-sized companies. 

Super 60 funds that invest in this part of the market include Artemis US Smaller Companies, abrdn Global Smaller Companies and Henderson Smaller Companies

Value-focused funds are also highly likely to avoid the Magnificent Seven, such as ACE 40-rated Schroder Global Sustainable Equity or Super 60-rated Artemis SmartGARP Global Equity.  

Equal weight funds, which attempt to have the same amount invested in each company in a portfolio, are another option. Two strategies to look at are the iShares S&P 500 Equal Weight UCITS ETF and Invesco S&P 500 Equal Weight ETF. Our recent article explained the main benefits of an equal-weight index.  

Investors who think the Magnificent Seven will keep performing well can get access via a Nasdaq 100 tracker fund, such as Invesco EQQQ Nasdaq 100 Ucits ETF or the iShares Nasdaq 100 UCITS ETF. All the seven shares are represented in the top 10 of these popular exchange-traded funds.  

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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