The Magnificent Seven: A Risky Bet or a Winning Strategy?
In the world of investing, there are always trends and hot stocks that everyone seems to be flocking to. Lately, the “Magnificent Seven” – Microsoft, Apple, Amazon, Google parent Alphabet, Tesla, Facebook parent Meta, and Nvidia – have been dominating the market. These tech giants have posted impressive gains, with some even exceeding 200%. However, not everyone is convinced that betting on these stocks is a wise move.
Jeffrey Gundlach’s Warning
One of the biggest names in the bond world, Jeffrey Gundlach, recently expressed sympathy for “poor” stock investors. While bondholders have been hit hard by rising interest rates, equity investors are still riding high on the wave of big tech stars. Gundlach warns that this gamble might not pay off in the long run.
Gundlach points out that there are attractive alternatives to stocks, such as Treasury bonds. With six-month Treasury bonds offering an annualized return of 5.58%, many investors are adopting a “T-bill and chill” strategy. They prefer to park their money in these low-risk, fixed-income securities and enjoy the predictability of regular interest payments.
The popularity of the Magnificent Seven has overshadowed other investment opportunities. Without these stocks, the S&P 500’s rise would have been significantly reduced. However, Gundlach suggests that this obsession could come to an end sooner than we think.
Is the Obsession Sustainable?
Predicting the end of the Magnificent Seven’s reign has proven difficult, and those who have bet against them have often been left embarrassed. The ease of following the crowd and the allure of big earnings make it hard for skeptics to look elsewhere. However, there are several factors that suggest this obsession might not be sustainable:
- The concentration of market capitalization: These seven stocks currently make up an astonishing 28% of the S&P 500’s market capitalization. The top 50 stocks account for 57%. Such concentration is rare and raises concerns about the overall health of the market.
- The cyclical nature of technology: While these companies have demonstrated impressive growth, they are not immune to economic downturns. As Gundlach points out, the people they are trying to sell to still face cyclical economic pressures. This vulnerability could impact their long-term performance.
- Alternative investment opportunities: Other investment strategies, such as stock picking and value investing, have shown success in specific market conditions. Japanese value stocks, for example, have outperformed their U.S. counterparts this year. Diversifying one’s portfolio and exploring different strategies can mitigate risk and enhance returns.
Considering these factors, it might be wise for investors to explore alternatives to the Magnificent Seven and diversify their portfolios.
The Risk of Momentum Trading
One risky strategy associated with the obsession over the Magnificent Seven is momentum trading. This involves buying expensive stocks that have already experienced a significant rally, in the hope that the upward momentum will continue. While this approach can yield substantial profits, it also carries inherent risks:
- Waiting for a cheaper entry point: Many investors who choose to relax on Treasury bonds might be waiting for a more opportune time to enter the stock market. This could reduce the amount of capital available for riskier bets, potentially impacting the momentum of these popular stocks.
- Dependence on market momentum: Momentum trading relies heavily on the continuation of existing market trends. If the momentum shifts or the market sentiment changes, these trades can quickly turn sour. Investors must carefully monitor the market and be prepared to exit positions when necessary.
- The finite number of buyers: With the increasing popularity of the Magnificent Seven, the number of available buyers for these stocks is decreasing. Many active funds already hold these stocks, and the pool of potential investors is shrinking. This limits the upside potential and exposes investors to potential downturns.
These risks highlight the importance of caution and diversification in one’s investment strategy.
Exploring Alternatives
While the Magnificent Seven has captivated investors’ attention, it is crucial to remember that there are other investment opportunities beyond these tech giants. By exploring alternatives, investors may find hidden gems and diversify their portfolios. Here are a few ideas:
- Value stocks: While growth stocks have dominated the market in recent years, value stocks have shown promising performance. Look for companies with solid fundamentals and attractive valuations.
- Small-cap stocks: The Russell 2000 index, which represents small-cap stocks, has experienced a slight decline this year. However, this segment of the market often presents opportunities for growth and can offer attractive returns.
- International markets: Don’t limit yourself to the U.S. market. Exploring international markets can provide exposure to different industries and economies, potentially diversifying risk and enhancing returns.
By considering these alternatives, investors can build well-rounded portfolios that are not solely reliant on the performance of a few high-flying stocks.
Conclusion
The Magnificent Seven has undoubtedly enjoyed tremendous success in recent years. However, wise investors must carefully assess the risks associated with concentrating their investments in a handful of stocks. While these tech giants have proven resilient, economic and market factors can impact their future performance.
Diversification and exploring alternative investment opportunities can help mitigate risk and enhance returns. By venturing beyond the Magnificent Seven, investors can uncover hidden gems and take advantage of market inefficiencies.
Summary
While the Magnificent Seven stocks continue to dominate the market, there are growing concerns about the sustainability of their success. Bond king Jeffrey Gundlach warns that equity investors might be making a risky bet by solely relying on these tech giants. Concentration of market capitalization, the cyclical nature of technology, and alternative investment opportunities are all factors to consider. Investors also face risks associated with momentum trading and a finite pool of buyers for these popular stocks. Exploring alternative investments and diversifying portfolios can help mitigate these risks. By thinking beyond the Magnificent Seven, investors can discover new opportunities and potentially achieve better long-term performance.
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Jeffrey Gundlach, one of the biggest names in the bond world, feels sorry for “poor” stock investors. Bondholders may have been hammered over the past two years by rising interest rates. But the founder of DoubleLine Capital warned that equity investors are still “living for the magnificent seven” – in effect making a risky bet in riding the wave of big tech stars.
With six months Treasury bonds offering an annualized return of 5.58%, the founder of DoubleLine Capital highlighted the popularity of a “T-bill and chill” strategy. That is, just park your money there and sit back.
“His 1696777334 exciting to be a bond investor,” he said at the annual meeting of bearish investors, hosted this week by Grant’s Interest Rate Observer in New York. “You can get 9% in bank loans. You can get 7.5% from triple-A floating rate assets in parts of the securitized market that will have no defaults.”
Few so far have felt pity for the holders of Microsoft, Apple, Amazon, Google parent Alphabet, Tesla, Facebook parent Meta, and Nvidia, which have posted gains ranging from about 35% this year (Apple and Microsoft) and beyond. above 200% (Nvidia). According to Goldman Sachs, the basket of sevens grew by just over 50% in the nine months to the end of September. Without them, the S&P 500’s 14% rise would have been reduced to a paltry 4%.
Predicting the end of investors’ obsession with the Magnificent Seven has so far embarrassed far more people than it has enriched. And with earnings so easy to follow from the crowd, it’s been hard for skeptics to bother selecting stocks among the index’s 493 other members — let alone consider looking for standout companies among the smaller companies. The small-cap benchmark, the Russell 2000, has fallen 2% this year.
Gundlach’s quip at the expense of equity investors highlights an important fact, however: There are now alternatives to stocks. Of course, the predictability of collecting regular interest payments, while attractive compared to recent memory, is not likely to excite an equity investor aiming for the moon.
But even a few months of investors “relaxing” on Treasuries, perhaps waiting for a cheaper entry point for stocks or waiting to see what the Federal Reserve will do, would reduce the amount available for riskier stock bets. And for trades that depend on momentum, such as buying expensive companies that have already rallied sharply, this can be a problem.
There’s also the question of how many investors will be left to buy the seven. Even the least favored of the bunch (Tesla) is already held by more than a third of active long-only funds, Bank of America strategists reported this week, while those same funds are overweight another five of the seven, compared to index. .
All but Microsoft have seen more funds invest this year, and with 85% of active funds holding the ChatGPT backer, there aren’t many left to step into. The BofA report puts it bluntly: there are “fewer funds left to buy(s) larger stocks.”
These seven stocks make up a remarkable 28% of the S&P 500’s market capitalization. The top 50 stocks account for 57%. Concentration on this scale is extremely rare. According to Absolute Strategy Research, there are only two other occasions – July 1932 and November 2000 – in the last 100 years when the 50 largest stocks have made up such a large share of the overall U.S. market value.
Unnecessarily for fans of history repeating itself, there are no real conclusions to draw about this; 1932 marked the bottom of the S&P 500 index, while 2000 came right after the peak.
ASR co-founder Ian Harnett sees this year’s stock market performance as a late-cycle moment that shows investors are ready to abandon caution in favor of pursuing the same — tech growth theme which has dominated in recent years. , however difficult it is to justify the ratings.
“Even if you believe these companies will remain structurally strong for a long time, you need to remember that the people they are trying to sell to still face cyclical economic pressures,” he says.
Although sevens have dominated the market debate, their returns are not as brilliant if you change the investment period. In the last three months, for example, only Nvidia, Facebook and Alphabet have grown. Over the course of two years, four out of seven remained flat or actually lost money to their shareholders.
Deeann Griebel, a financial advisor based in Mesa, Arizona, says her clients are already starting to have second thoughts. “Since they don’t make easy money anymore, they’re willing to listen to other ideas.”
Is it time to get back to stock picking again? Harnett points out that the nimble bargain hunters might have done better than the headlines suggest. Japanese value stocks, for example, are up 26% this year, but their U.S. equivalents have gained just 4%.
“It’s actually been a year of stock picking with different strategies that have been successful depending on the market,” he says. “The fact is, to outperform with your choices, you absolutely had to turn the lights off.”
jennifer.hughes@ft.com
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