“Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.” ~ Howard Marks
Prologue
The narrative of late last year continues with economic resilience, moderating inflation, equity markets continue to be led by the megacap Tech names. Small caps have been lagging, perhaps as a result of the Fed rate cut uncertainty – predicting interest rates is a fool’s errand, see Chart of the Month. With the S&P 500 rallying about 20% since the late-October lows, a period of consolidation and volatility is likely as much of the good news has already been priced in.
Markets are currently facing a variety of geopolitical and economic crosscurrents, including the highest levels of equity market concentration since the dot-com bubble along with questions about economic growth and inflation. Politics continue to be front and center in the media. According to a few articles I’ve read, more than 2 billion voters in fifty countries will head to the polls in 2024.
For decades, long-term investors have withstood the turmoil in the markets. From the higher highs to the most volatile of drawdowns, investors succeed by not concentrating on what happens in their portfolio next month but what happens rather in the next five years. It is important to understand that this election cycle should be no different. While 2024 will be an instrumental year in determining many of the world’s most crucial decision makers, it may be too early to determine the impacts on the broader markets.
In terms of portfolio positioning, at this point in the election cycle, it is too early to separate the winners from the losers. It makes sense to remain invested in a well-diversified portfolio, that fits your long-term goals. The Magnificent Seven remain dominant but there is a case to be made for diversification given their lofty valuation, see Article of the Month. With cash rates elevated, holding sufficient liquidity to meet near term capital needs is prudent, especially should we encounter volatility.
Please reach out with questions.
-Paul
Noteworthy links:
- Capital Group: Rob Lovelace on what’s in store for 2024 R
- aymond James: Debunking the US National Debt Problem
- Raymond James: Effects of higher interest rates on housing and consumers
Chart of the Month
Magnificent Seven: What do you need to believe?
Article of the Month
Magnificent Seven: What do you need to believe?
Capital Group, published January 9th, 2024.
The Magnificent Seven stocks – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – now sport a market cap of around $12 trillion. Looking further into the market, the sales and profitability of the next $12 trillion in market cap are represented by 42 companies from a broad set of industries ranging from tech and health care to financials and consumer companies.
Both the 12-month forward sales and earnings for this next set of companies making up a $12 trillion market cap are higher than for the Magnificent Seven, according to LSEG’s data as of December 31, 2023 – yet another data point indicating U.S. stock market performance could broaden in the coming years, pending earnings outlooks.
Our focus remains on valuations given the rise in share prices for the Magnificent Seven. The S&P 500 has a forward price-to-earnings (P/E) ratio of about 15.5x excluding the Magnificent Seven, while the Magnificent Seven has a P/E of about 35x, according to data compiled by FactSet as of January 2, 2024. Earnings growth estimates in 2024 bring the division into high relief – the Magnificent Seven boasts 20.8%, with the S&P 500 at 11.5%, and S&P 500 sans-Magnificent Seven at 6.7% respectively. For 2025, earnings growth estimates for those three groups are projected at about 17%, 12% and 6.7%, respectively. Longer-term earnings estimates for the M7 remain higher, but the uncertainty band around them would also be higher. Hence, the need to diversify.
There’s a strong case to be made for the companies apart from their stock performance. The Bloomberg Magnificent 7 Total Return Index advanced 107% in 2023 versus the overall S&P 500 Index at 24%, largely because the positive fundamentals more than offset headwinds from rising interest rates. In 2023, these companies implemented stronger cost discipline through headcount reductions and capital reallocation to more profitable projects.
Sound balance sheets and strong cash generation give the Magnificent Seven an edge to invest in research and development, while also investing in artificial intelligence (AI) to potentially drive growth in the coming years. Last year, these companies in aggregate spent over $170 billion in capital expenditures and over $200 billion on research and development on initiatives that might have a secular impact on the economy, such as AI applications.
Risks to the group include elevated investor expectations after strong earnings in a choppy economic environment. Additionally, signs of global economic weakness could impact certain big-cap tech stocks more than others. Heightened geopolitical tensions and regulatory questions may also linger throughout 2024.
Nevertheless, investors may want to consider some exposure to the Magnificent Seven and also a broader set of stocks within the S&P 500 -- as well as non-U.S. markets, where in some cases valuations are reasonable and prospects for both top-line and bottom-line growth look promising.
Here is a link to the full article: Magnificent Seven: What do you need to believe?
*Raymond James & Associates, Inc, member New York Stock Exchange/SIPC
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