Neil Birrell, Premier Miton’s Chief Investment Officer and lead manager of the Premier Miton Diversified Fund range, looks at one of the biggest investment themes and driver of equity markets we have experienced.
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
We started out with the FANGs, moved onto the FAANGs, then FAANG+, then FANGAM, then the Magnificent 7 and probably some acronyms I have missed on the way. Anyway, I’m sure I don’t need to tell you that these are all some combination of Facebook (Meta Platforms as it is now named), Apple, Amazon, Netflix, Google (now Alphabet), Tesla, Nvidia and Microsoft.
These giant US technology (or car manufacturing) and communications companies have driven equity indices higher over many periods since COVID arrived and, particularly through 2023.
A quick search on Google (how ironic) will show you just how many indices these companies appear in, particularly Apple. So, if you invest in index tracking funds, ETFs or active funds that stay close to global or US indices, you are very likely to have quite a lot of exposure to these companies. That may well be true for genuinely active funds as well, given the size and importance of the companies.
Let me make one thing clear
I am not, and never have been a believer in the view that we are reliving a repeat of the Dot Com bubble and bust of 20 – 25 years ago. I do not believe that Apple could be the next Nokia, or Nvidia the next Cisco Systems, they are very, very different companies and these are very different times.
The Dot Com boom was based on hope rather than reality and many companies were not as well positioned, as well financed, as well managed or had such good products or services as companies today, in particular the specific ones I am referring to here.
However, what is in common between the Dot Com boom and today, is the high valuations that companies are attracting. But there have been good reasons for this, I’ll expand on that below. Also, investors have not been overly discriminating in their investment decision making, with the exception of Netflix falling out of favour 2 years ago, before joining the party again. They have been, for the most part, seen as a homogeneous group and they certainly are not that!
The recent past
COVID was a catalyst for the share prices of these companies to race higher, demand for their products surged and investors craved earnings growth in a period of huge uncertainty and collapsing earnings elsewhere. Lower interest rates also increased the current value of future earnings.
Through 2022 the Mag 7 sold off as lockdowns ended, economies recovered and more cyclical companies benefited, also towards the end of the year US / China trade war concerns heightened, which would have been particularly impactful for technology companies. The group got back to share prices not seen for some time with valuations that were low enough to be attractive to many investors, leading to a strong start to 2023.
In the spring of 2023, we had the banking crisis, that turned out not to be a crisis, but it did mean that the expectations for interest rate cuts exploded, fears of recession spiked, and risk aversion was the order of the day. Investors found sanctuary in the safety of hugging indices and the strong cash flows and balance sheets of the Mag 7. Artificial Intelligence (AI) hit the headlines as well, which added fuel to the buying fire, justified by enormous hikes in earnings guidance for the likes of Nvidia and to a lesser extent Microsoft.
The share prices of these companies drove US and global equity indices higher and onto excellent returns for 2023.
What of 2024?
Some of the Mag 7 have become much more expensive in valuation terms than others and the outlook for earnings growth is very different as well, particularly given AI. As we move through the period of inflation and interest rates driving share prices, it is reasonable to expect those factors to become less important and company fundamentals to become more important and start driving share prices. That could well be the trigger for the Mag 7 to be much less influential as a group and to reduce in number.
To give an example of this, let’s compare Apple, for some time the world’s largest company (but as I write this, it has been eclipsed by Microsoft) and Nvidia.
The top chart below shows the earnings revisions for Apple (light blue and orange) since the start of 2021, plotted against the share price (dark blue). The earnings revisions have stopped rising as steeply as they did and have flattened out. The result of that can be seen in the bottom of the two charts, which is the price / earnings ratio, a good measure of valuation, of Apple for the current year (light blue) and the following year (dark blue). Apple has got a lot more expensive through 2023.
Apple Earnings Revisions vs Share Price
Source: Bloomberg 07.01.2021 to 11.01.2024. The orange line is for that current financial year, the blue line is for the following financial year, ending September. Past performance is not a reliable indicator of future returns.
Apple Price to Earnings Ratio
Source: Bloomberg 07.01.2021 to 11.01.20214. PE (price/ earnings) ratio 1FY is for that current financial year, 2FY is for the following financial year, ending September.
Now let’s look at the same thing for Nvidia, it has got a lot cheaper through 2023.
Nvidia Earnings Revisions vs Share Price
Source: Bloomberg 04.01.2021 to 11.01.2024. The orange line is for that current financial year, the blue line is for the following financial year, ending January.
Nvidia Price to Earnings Ratio
Source: Bloomberg 04.01.2021 to 11.01.2024. PE (price/ earnings) ratio 1FY is for that current financial year, 2FY is for the following financial year, ending January.
If you were to do the same analysis, you would see that Meta Platforms looks like Apple and Microsoft shows similar traits, but more diluted, to Nvidia.
None of that means that the share prices of all these companies can’t carry on up. But rational thinking would suggest it will be more difficult for that to happen and that there is likely to be bifurcation within the group.
My view would be that the days of the magnificence of the Magnificent 7 are numbered, but that some will continue to do well and others will not. Simply; don’t put all 7 of your eggs in the same basket.