Yearender: Can sizzling Magnificent Seven trade keep powering US stocks in 2024?

Vontobel Holding AG

29/12/2023 21:55

(Updates with year-end prices)
    By Lewis Krauskopf
       NEW YORK, Dec 29 (Reuters) - As a strong year in U.S.
stocks comes to a close, fund managers face a potentially
consequential choice in 2024: stick with the few massive growth
and technology names that have powered equity indexes higher, or
take a shot on the rest of the market.
    Shares of the so-called Magnificent Seven – Apple  AAPL.O ,
Microsoft  MSFT.O , Alphabet  GOOGL.O , Amazon  AMZN.O , Nvidia
 NVDA.O , Meta Platforms  META.O  and Tesla  TSLA.O  –
individually soared between around 50% and 240% in 2023, making
them among the market's most rewarding bets. 
    Because of their heavy weightings in the S&P 500  .SPX , the
seven were responsible for nearly two-thirds of the benchmark
index's 24% gain this year, data earlier this month showed. The
Nasdaq Composite  .IXIC , which has a heavier focus on tech,
surged 43.4% this year, its biggest annual rise since 2020.
    Not surprisingly, fund managers in BofA Global Research's
most recent survey said owning the seven stocks was the market's
"most crowded" trade. 
    But expectations that the Federal Reserve will cut interest
rates next year while the economy avoids recession have awoken
other parts of the market in recent weeks. Meanwhile, some
investors say the huge rallies in the seven may have left them
overvalued or vulnerable to profit-taking.
    "When you have seven companies that are huge in the index
all going up, that is good for the market," said Jonathan
Cofsky, portfolio manager for the Global Technology and
Innovation team at Janus Henderson Investors. "But I think there
are probably more opportunities in the rest of the market,
depending on rates and the economy."
    Data earlier this week from the Apollo Group showed 72% of
the S&P 500's stocks underperformed the index this year, a
record. 
    However, there are signs the rally is broadening. The
equal-weight S&P 500  .SPXEW  -- a proxy for the average stock
-- climbed 6.7% in December against a 4.5% rise for the standard
index, after lagging most of the year. 
    Meanwhile, the previously sluggish small-cap Russell 2000
 .RUT  soared 12% in December, its biggest monthly gain in three
years.
    With the weighting of the Magnificent Seven in the S&P 500
swelling, a bad year for the group could spell trouble for the
broader market if other stocks don't take up the slack. 
    Other important factors for the market next year include
whether inflation continues to ebb, allowing the Fed to cut
rates at the pace markets expect, as well as the continued
resilience of the U.S. economy. The run-up to the U.S.
presidential elections in November also could increase market
volatility.
    Of course, other areas of the market might struggle to
replicate features that attracted investors to the seven in the
first place. Their size and competitive advantages made them a
refuge for investors worried about economic fallout from
aggressive monetary policy tightening the Fed embarked on to
calm surging inflation. 
    Excitement over the business potential from emerging
artificial intelligence technology also helped propel some of
the megacaps in 2023, including Nvidia and Microsoft, which
jumped 239% and 57%, respectively.

    
    Another factor is profitability: the Magnificent Seven are
expected to post a 39.5% aggregate earnings increase in 2023,
against a 2.6% decline for the rest of the S&P 500, according to
LSEG data. Their earnings growth is expected to outperform again
in 2024, albeit by a lesser extent.
    But the Magnificent Seven stocks are trading at more
expensive valuations overall after their gains. According to
LSEG Datastream, they recently traded at an average forward
price-to-earnings ratio of 33.6 times, while the S&P 500 was at
19.8 times.
    "They don't get the low-hanging fruit of coming into this
year weak as ... a starting point," said Matt Benkendorf, chief
investment officer of the Vontobel Quality Growth Boutique.
    Vontobel Quality Growth holds Microsoft, Amazon and Alphabet
in its portfolios, but not the other four companies where
Benkendorf sees more operating challenges.
    Cofsky, meanwhile, said his funds own at least some of the
Magnificent Seven but he sees potential rotation into small or
mid-cap tech stocks in 2024 if rates continue to moderate.
    BMO Capital Markets strategist Brian Belski recommended
investors own "a little bit of everything" in the coming year,
given his "expectation for individual stock participation to
broaden significantly," following narrow breadth relative to
history in 2023.
    Others believe the Magnificent Seven will continue drawing
investors hoping for a repeat of their performance this year. 
    The Magnificent Seven's dominance in key indexes means they
are widely owned by mutual funds and ETFs and may benefit as
money comes off the sidelines into stocks, said Francisco Bido,
senior portfolio manager at F/m Investments.
    He counts all of the seven as long-term holdings in his
portfolios, except for Tesla. 
    "It's a little bit of a feedback loop," Bido said. "They get
bigger, people want even more."

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Big year for big stocks    https://tmsnrt.rs/48pibpG
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 (Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili,
Rosalba O'Brien and Daniel Wallis)
 ((lewis.krauskopf@thomsonreuters.com; Twitter: @LKrauskopf;))