The “Magnificent Seven” — Is Mega-Cap Tech a Safe Haven or a Bubble?

S&P 500® v. Mega-Cap Tech Share Price Growth (YTD as of 8/10/23)

Source: FactSet.com

The S&P 500® index is a product of S&P Dow Jones Indices, LLC and/or its affiliates (collectively, “S&P Dow Jones”) and has been licensed for use by Segal Marco Advisors. ©2023 S&P Dow Jones Indices, LLC a division of S&P Global Inc. and/or its affiliates. All rights reserved. Please see www.spdji.com for additional information about trademarks and limitations of liability.

There are a few key reasons why these companies led the market during the first and second quarters; some of which may be short term, while others may continue to be drivers of performance.

The macro backdrop going in…

Monetary policy, geopolitical tensions and the U.S. domestic economy are key variables that can influence financial market performance. This article focuses on the key components of inflation, interest rates and the U.S. Federal Reserve’s (the Fed’s) monetary tools. As seen in the graph below, inflation, as measured by the consumer price index, has been experiencing a cyclical rise to its highest level since the early 1980s.

CPI Inflation

Source: Bureau of Labor Statistics

This dramatic increase in inflation has caused the Fed and central banks across the globe to raise interest rates to try and slow down the economy and inflation. As of the most recent CPI print, inflation, as measured by total CPI, has fallen to 3.2 percent, with core CPI (inflation excluding food and energy) at 4.7 percent.

The Fed Funds Rate (FFR) is the interest rate at which financial depository institutions lend their reserve balances to each other and is the primary tool the Fed uses to influence the U.S. economy. Principally, by increasing the FFR, it becomes more expensive for these large institutions to borrow, which lowers the supply of available money and increases interest rates in the short term. All this is done with the aim of slowing down and lowering inflation. In 2023, the Fed raised the FFR at the quickest pace in history. As seen below, the FFR is now at 5.33 percent. This is 300 basis points higher than it was just a year ago.

U.S. Federal Funds Target Rate

Source: FactSet.com used with permission

The U.S. economy has experienced a rise in interest rates of historic proportions to combat the largest inflation cycle since the 1980s, all while the greater global geopolitical environment remains volatile and uncertain.

The S&P 500^® and mega-cap stocks

The S&P 500^® is a market capitalization (market cap)-weighted index. Market cap is the total value of a company’s outstanding shares, and the S&P 500^® is designed to weight each of its holdings by that measure of size. That means the index has a higher weighting to larger companies as the weights shift based on changing company market values.

The Magnificent Seven companies of the S&P 500^® — Apple, Microsoft, Amazon, NVIDIA, Alphabet, Meta and Tesla (in order by descending weight in the S&P 500^®) — are seven of the largest companies within the S&P 500^® (with Tesla recently dropping to eight behind Berkshire Hathaway). Apple and Microsoft alone made up over 13 percent of the index, with the entire seven aggregating for over 25 percent. The combined market capitalization of the top seven companies in the S&P 500^® is roughly $11 trillion. That is over three and a half times the size of the $3 trillion market cap of the Russell 2000, which is the entire index of 2,000 small cap stocks.

Due to the weighting scheme of the index, the S&P 500^® will outperform if its top holdings do.

The graph below shows the S&P 500^®’s performance through the most recent CPI print (August 10, 2023) against itself with and without the top seven mega-cap growth companies. 

S&P 500® Performance Comparison

Source: FactSet.com; Index, 2023: Jan 1 = 100, used with permission

The S&P 500® index is a product of S&P Dow Jones Indices, LLC and/or its affiliates (collectively, “S&P Dow Jones”) and has been licensed for use by Segal Marco Advisors. ©2023 S&P Dow Jones Indices, LLC a division of S&P Global Inc. and/or its affiliates. All rights reserved. Please see www.spdji.com for additional information about trademarks and limitations of liability.

Although the S&P 500^® has benefited so far in 2023 of almost 17 percent, much of that outperformance can be explained by a handful of companies. The graph below compares the S&P 500^® total returns in 2023 against just these top seven constituents by month. As visualized, these companies have seen their values grow on a much larger scale than the index itself. The Magnificent Seven stocks in the S&P 500^® have contributed 74 percent of the total return year to date through August 10. Meaning, 12.47 percent of the 16.89 percent return for first six months was contributed by seven stocks and only 4.42 percent from the other 493 stocks.

S&P 500® Total Return Comparison

Source: FactSet.com; Index, 2023: Jan 1 = 100, used with permission

The S&P 500® index is a product of S&P Dow Jones Indices, LLC and/or its affiliates (collectively, “S&P Dow Jones”) and has been licensed for use by Segal Marco Advisors. ©2023 S&P Dow Jones Indices, LLC a division of S&P Global Inc. and/or its affiliates. All rights reserved. Please see www.spdji.com for additional information about trademarks and limitations of liability.

The Magnificent Seven are generally referred to as technology companies, but it is notable that of them, only three — Apple, Microsoft and NVIDIA — are classified in the Technology sector of the S&P 500^® by Standard and Poor’s. Within the S&P 500^®, Amazon and Tesla are classified as Consumer Discretionary with Alphabet and Meta sitting in the Communication Services bucket. This makes for meaningful cross correlation between the performance in the sectors of the index in periods when the large cap stocks are moving in tandem.

So, why are these seven companies doing so well in the first place?

Cash is king in investors’ minds

While it is difficult to fully gauge the reasons behind short-term sentiment and performance in equity markets, these companies have a few qualities in common that investors seem to be valuing in 2023. High levels of cash for these seven companies may have boosted their appeal with investors. With respect to fundamentals, mega-cap growth companies, such as Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla tend to generate large amounts of free cash flow and can accumulate large cash reserves. This group consists of four of the 10 largest cash positions on balance sheets in the S&P 500^® Index.

The next graph shows the total level of cash and short-term securities of these notable growth companies compared to the average of the top 100 companies in the index. These seven companies in the S&P 500^® average much higher cash balances than the rest of the top 100 in the index (excluding Financials) and over $48 billion more in cash than the average company in the index. Overall, strength in company fundamentals, such as high cash balances, can provide investors with a feeling of safety during difficult economic periods.

Magnificent Seven Cash Balance v. the Average Company in the S&P 500®

Source: FactSet.com used with permission

Reversion of multiple compression

As more sentiment has grown towards U.S. inflation moderating and the Fed coming to the end of their interest rate hikes, there is a case that these mega-cap growth companies helped weather the storm. Using the common definition of a bear market where a stock market falls by more than 20 percent, the most recent bear market began in June 2022. This trough in the cycle included the S&P 500^® tech sector falling by over 24 percent. Meanwhile, thus far in 2023, that same sector has posted a 36 percent return. The NASDAQ, a technology-heavy composite, was down 30 percent in 2022. It has posted a 32 percent return year to date through August 10. Such returns in 2023 are notable, but the low base for big tech that was set up by the market drag in 2022 provided these mega-cap growth companies with an easier opportunity to outperform in the first half of 2023.

Taking advantage of artificial intelligence

Beginning earlier this year, new developments in artificial intelligence (AI) have also added a boost to technology companies. As seen below, over the past five years, AI has become a large topic of interest that is on par or exceeding other technological developments over that period and not just within financial markets.

Google Search Traffic

Source: Google Trends

All the Magnificent Seven companies have some level of relationship to AI within their business operations as follows:

• Alphabet — cloud service provider, implementing AI across suite of consumer products (G-Suite, Bard)
• Amazon — cloud service provider, implementing AI across suite of consumer products (retail)
• Microsoft — cloud service provider, implementing AI across suite of consumer products (Office Suite, OpenAI)
• Apple — large technology platform, integrates AI through products
• Meta — large consumer data sets, AI uses through suite of consumer products
• NVIDIA — designs the best-in-class graphics card for AI, machine learning processing
• Tesla — self-driving software

The varied levels of AI exposure have been an added layer to investor interest for these large-growth companies. But AI becoming a revenue generator for companies is still not a reality in 2023.

Where do we go from here?

The stock performance of the Magnificent Seven companies has helped the S&P 500^® navigate a bear market via investor interest in strong balance sheets and business level exposure to areas of high growth technology that would benefit from progress in the domestic macroeconomic conditions. Recent developments in AI provide more positive sentiment higher expectations for these companies moving forward. However, any fall from grace for the Magnificent Seven could be severe for U.S. equity markets.

The magnitude of concentration in the S&P 500^® is meaningful to returns in 2023. The top five holdings in the S&P 500^® in 1990 made up over 12 percent of the index. Just two holdings — Apple and Microsoft — alone constitute more weight in the index today. When considered with the niche classifications of these “technology” companies in the respective sectors of the index, sector cross correlations are also notable.

These mega-cap growth companies have garnered investor interest. To date, returns have been generated largely by multiple expansion. Will earnings come through to provide the support for the multiples? That remains to be seen.

All opinions asserted in this article can be nonfactual in nature, assume certain economic condition as well as industry developments, and constitute current opinions that are subject to change without notice. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This article and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. Investing involves risk of loss, which investors should be prepared to bear. On all matters involving legal interpretations and regulatory issues, investors should consult legal counsel and tax advisors on matters related to taxation.