The Magnificent Seven: A Cautionary Tale for Investors

Did you know that the term "Magnificent Seven" was originally intended as a warning rather than a ringing endorsement? It's essential to examine both the risks and rewards associated with owning these leading tech stocks.

Most investors are familiar with the so-called "Magnificent Seven" stocks. However, the name was chosen more as a caution than a compliment. This becomes increasingly clear as we analyze the potential downsides highlighted by Bank of America executive Michael Hartnett.

What Are the Magnificent Seven Stocks?

This group of powerful tech companies has significantly influenced the performance of the S&P 500 index over the past two years. To help remember the seven companies, I used a mnemonic, “MAMA ANT,” which includes four software companies and three hardware producers:

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

Additionally, the hardware companies represented are:

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

These companies, recognized as leaders in artificial intelligence and electric vehicles, have played a significant role in shaping the stock market landscape.

As of November 2024, these companies remain at the forefront of the market. Initially, they were among the ten largest American stocks by market capitalization. By now, they stand as the top seven, with only two—Microsoft and Apple—lagging behind the S&P 500 since May of the previous year. The rest have seen remarkable gains, contributing to an increase in the cap-weighted index.

What Are the Risks Associated with This Group?

From the perspective of May 2023, Hartnett pointed out several risks linked to these dominant tech stocks:

• The expectation that the federal funds interest rate would rise above 4% markedly increased, with the actual rate climbing to 5.3% within three months due to inflation concerns.
• This group of tech giants accounted for nearly all the significant gains in early 2023. Meanwhile, almost half of the S&P 500 companies saw their stock values decline that spring, but companies like Nvidia and Meta Platforms experienced tremendous growth.
• As these stocks were already large when the AI boom began, their influence on market indexes—weighted by market capitalization—has grown. Currently, the Magnificent Seven represents 32.2% of the S&P 500's total value, an increase from 27.3% in May 2023 and 20.1% at the end of 2022. This concentration has resulted in market risks, as heavy reliance on a small group of stocks can lead to instability.
• Hartnett also referenced a so-called "baby bubble" around AI in 2023. Regardless of whether AI is a long-lasting transformative trend or a significant market bubble, it is clear that it represents something substantial.

Michael Hartnett's naming of this stock group was both clever and cautionary, borrowing from the title of a famous Western that ended tragically. While other names could have been chosen—like "seven deadly sins" or "seven plagues"—the terminology used has served as a significant indicator of caution.

In the classic film, only three of the Magnificent Seven survive the final showdown. This metaphor illustrates potential future risks as we evaluate whether today's tech giants remain viable investments. Investors should remain vigilant about possibly inflated valuations within the tech industry.

Strategies for Navigating the Magnificent Seven Today

Currently, the average S&P 500 stock is valued at 28.7 times its price-to-earnings (P/E) ratio and 23.6 times its price-to-cash reserves (P/C). Within this group, Alphabet and Meta Platforms present themselves as reasonably priced AI leaders, whereas companies like Tesla and Nvidia appear significantly overpriced:

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

This data highlights the critical reliance of key market indicators on these seven influential companies, a reliance that is steadily increasing. Should one of these firms encounter unexpected challenges, the ripple effects could impact the overall stock market—a scenario that Hartnett sought to warn investors about.

When investing in promising sectors like AI and electric vehicles, it is essential to proceed with caution. A well-rounded and diversified portfolio can help mitigate risks and promote long-term financial growth. The key message Hartnett conveyed through the Magnificent Seven designation was that while these top-performing stocks appeared attractive in spring 2023 (and still do), they may pose threats to your portfolio in the future.

Stocks, Investing, Risk