US indexes trounced global share markets in 2023. The S&P 500 ended the year up 25% and the Nasdaq 100 55%. Powering them to near record highs, were a narrow group of stocks, dubbed the ‘Magnificent 7’. But as valuations reach insane levels, I see only one outcome: a stock market crash.
Valuations matter
Wall Street analysts believe that the Magnificent 7 are bulletproof companies, primed to be major beneficiaries of the artificial intelligence gold rush. This faith is demonstrated by the hefty price-to-earnings multiples placed on them.
Company
Trailing P/E multiple
Apple
31
Alphabet
24
Amazon
68
Meta
21
Microsoft
35
Nvidia
58
Tesla
76
Median
35
Magnificent 7 P/E multiples
I believe that it’s way too early to know which, if any, will emerge as the market leaders from the AI revolution.
My argument is not that these companies aren’t highly profitable with sizeable moats. Instead, it’s based on the fact that too many investors are looking in the rear-view mirror when it comes to both valuing them and projecting their growth into the future.
Concentration of stocks
They say that history never repeats itself, but it often rhymes. If history has taught us anything, it’s that whenever stock market gains are confined to a handful of stocks, it never ends well.
In the early 1970s, a narrow group of 50 (coined the Nifty-Fifty) stocks, led by the likes of Procter & Gamble, IBM, Xerox and Polaroid were viewed as indestructible. As a consequence, valuations became stretched. During the bear market of 1973-74, they lost nearly 75% of their value.
Today’s market dynamics are unprecedented and make those 50 stocks look like a well-diversified portfolio compared to just the Magnificent 7! Both Apple and Microsoft alone account for 14% of the overall weighting in SPY S&P 500, the largest exchange-trade fund (ETF) in the world. For QQQ, which tracks the Nasdaq, it’s an astonishing 21%.
Changing capital dynamics
The emergence of generative AI clearly represents a paradigm shift. But the way it’s being marketed to investors is no different from previous technological breakthroughs.
Leading up to the 1973 crash, Xerox was one of the most innovative companies in the world. It marketed its photocopier as the office of the future. And it was right. The problem was that it took nearly 30 years before its share price revisited its peak.
Consider the companies that built the Internet over the past 20 years. Many of them emerged after the tech bust in 2000. These startups exploited existing Internet technologies in innovative ways to disrupt incumbents.
What’s becoming increasingly apparent is that building AI systems doesn’t come cheap. Microsoft’s move to bring Sam Altman (the CEO of OpenAI) in-house is very instructive. AI may be sold as a gold rush, but who’s doing all the panning for it? The Magnificent 7.
As they pour money into the space, free cash flow is declining. Some for the first time in their history.
Investors are placing a ton of faith in the generals. But companies with the deepest pockets and cleverest minds, don’t always win out in the long run. Fear of missing out (FOMO) may be driving investor decision-making, but I’m keeping my feet firmly on the ground. For now, I’m looking for opportunities elsewhere.
The post Why I don’t think the Magnificent 7 can save the US stock market from crashing appeared first on The Motley Fool UK.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Andrew Mackie has no position in any of the shares mentioned. The Motley Fool UK has recommended Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
