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The writing is on the wall for the Magnificent Seven

By some measures market breadth has fallen to its lowest levels in more than 20 years as the “Magnificent Seven” reign supreme. Investors should position for a broadening out of equity market leadership.
Analysis

The fundamentals of the Magnificent Seven (Apple, Amazon, Alphabet, Nvidia, Meta, Microsoft and Tesla) are undoubtedly impressive, but concentration within them has reached levels that are “extreme and historically unsustainable”, according to Allspring Global Investments. How concentrated, exactly? For the combined cost of buying them, you could buy the entire small- and mid-cap (SMID) universe – with $4.5 trillion to spare.

And Allspring argues that maybe you should (well, not all of it). Beginning in 2018, SMID valuations began lagging large caps in a trend that only accelerated since the start of the Covid-19 pandemic. That’s created favourable valuations for smaller segments of the US equity universe – the Russell 2500 Index is trading at a 21 per cent discount, the lowest valuation in 20 years.

Of course, investors might be getting good value for crowding into the Mag Seven too, concentration risk aside. But Allspring notes that SMIDs produced nearly four times higher revenues while trading at less than half the PE multiple of the Mag Seven.

  • “Investors in the Mag Seven are achieving lower growth rates and are paying a much higher price for each dollar of earnings,” Allspring’s Discovery Growth Equity team wrote in a note titled Historic Extremes Create Extreme Opportunities. “In short, investors in the Mag Seven are not getting good value for their money.”

    And while mega cap technology companies have enjoyed outsized return gains in 2023, this is fully reflected in their “bloated” market capitalisations”. The economy now appears to be slowing significantly as the global hiking cycle begins to have an impact, while elevated valuations imply “sky-high expectations”.

    “Should any of these bellwether companies miss or guide down financial results, valuations could compress nearly as fast as they expanded,” the note says. “Indeed, this has happened in the past when groups of stocks traded at valuations that exceeded fundamental reality.

    “Even if their profitability in nominal terms holds up, their extreme valuations may not fare as well as their businesses eventually converge with low-single-digit gross domestic product growth. The writing is on the wall: now is an excellent time to position for a change in market leadership.”

    Staff Writer


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