Time for the Magnificent Seven to Share the Spotlight

Driven by the excitement of artificial intelligence, the “Magnificent Seven” stocks (Apple, Microsoft, Amazon, Alphabet, Nvidia, Tesla, and Meta) were responsible for an overwhelming majority of the gains in the U.S. market earlier this year.

The market has not been this narrow in 30 years. Even though these seven companies accounted for only about 14% of the total S&P 500 profits last quarter, the Magnificent Seven represented 30% of its market capitalization and 70% of the returns in the first half of the year.

Lately, however, the market has been broadening out. Sectors that have sat on the sidelines for much of the year while these AI names have hogged the spotlight are now finally catching up. And for good reason: they’re cheap.

So far in July, leadership in the market has come from banks (+17%), energy (+5%), and metals and mining (+3%). Laggards have been consumer staples (+3%), technology (+2%), consumer discretionary (2%), and health care (+1%).

According to Goldman Sachs, the Magnificent Seven stocks trade at a 32 times price-to-earnings multiple. For context, the market historically trades around 16 times. The bottom 493 companies in the S&P 500 trade at only 17 times earnings.

These multiples are stretched too far. We believe that much of the future growth that will be generated from future AI revenue is reflected in many stock valuations today.

Gains in Information Technology have come through multiple expansion this year rather than actual growth. When comparing the April-June quarter in 2023 to 2022, revenue and profits in the Information Technology sector fell 0.7% and 0.6%, respectively.

For the rest of the year, we expect the market to continue to broaden out, lifting sectors that have lagged for the first half of the year. We favour dividend-paying stocks that will attract more investors next year as interest rates start to fall.

-Jeff Pollock

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