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If you own shares of Apple, Microsoft, Nvidia, Tesla, Meta, Amazon, or Alphabet (the Magnificent 7), then you should be happy with their recent performance. These seven stocks have had a magnificent 2023, up a combined 120%.
And so far this year (as of 2/2/2024), these seven stocks are up 12.3%, whereas the S&P 500 is up 4.5%.
The rise of these tech stocks can largely be explained due to generative artificial intelligence, boosting Nvidia, Microsoft, Amazon, and others. These are high-quality businesses that have seen an extraordinary amount of success. The recent optimism is due to the idea that AI technology is at the start of a business cycle and these companies are in a position to benefit.
The question you need to ask yourself – if these companies are well-positioned, how long will it take for this AI-related revenue show up in the numbers for these companies?
Carrying the Market
In a sense, these large cap tech stocks are carrying the rest of the market. Not all U.S. stocks performed well last year. 3/4 stocks underperformed the benchmark, one of the worst years on record.
On average, 49% of the S&P 500 will outperform the benchmark in any given year, as one would expect. Three-quarters of stocks underperforming in 2023 is signaling weakness in the broader market.
Stock Speculation Hits Extreme
As large tech companies rallied the past few years, the fear of a market bubble has grown.
One of my favorite ratios is the Nasdaq 100 / Russell 2000. This compares the difference between the tech-heavy Nasdaq index (large growth stocks) to that of US small cap stocks.
The spread between the two is hitting very frothy, peak-2000 dot-com levels. This should make you pause a bit.
To be fair, the dot-com bubble of the late 1990s was full of companies with little-to-no profit (and sometimes meager revenues). This is a different era.
AI is still in its infancy and the small number of winners will shape the future of the industry. Unlike the dot-com bubble, AI has real-world applications and is already delivering tangible value. The dot-com bubble was more novelty, the technology was still in its exploration phase, and its tangible value took years to develop.
However, AI is still an emerging technology, with frothy investments, a lot of new entrants, and inflated expectations. The upside is there, but so are the risks.
History Tells Us A Story
Every single member of the Magnificent 7, with Tesla being the exception, are trillion dollar companies.
In fact, all of the stocks that make up the Magnificent 7 are within the top 10 largest companies in the U.S. While that sounds great at first, if you are hoping for outsized returns in the future, history says that this fact is not great news.
After joining the ten largest U.S. stocks, the 3 year, 5 year, and 10 year annualized returns are 0.6%, -0.9%, and -1.5% respectively. What goes up does not always continue to go up.
Jan 1927 - Dec 2022
Does this mean that the Magnificent Seven’s forward-looking returns are bleak? Not necessarily. There will always be exceptions to the rule. But which stock will be the exception and under what circumstances is unknown.
If you have a sizable position in one of these stocks, at least be aware of the risks inherent in that position. Things may look great today, but as with all things, it won’t last forever.