The market’s excitement around AI may be new, but the investors flocking to high-profile tech companies have had their day before. In other words: buyer beware.
The stunning rise of the “Magnificent Seven” resembles bubbles of the past, which analysts say pose risks of arriving too late Investors who are less likely to achieve high returns as prices rise. Parallels to the dot-com boom of the late 1990s and subsequent collapse – who could forget Pets.com and Webvan? – have once again attracted attention.
In the early 2000s, the Fed tightened, real yields rose, and although central bankers eventually eased monetary policy aggressively, it failed to calm the jittery stock market, said Nicole Tanenbaum, partner and chief investment strategist at Checkers Financial Management.
Goldman Sachs research shows the S&P 500 has never been more top-heavy, driving gains in a handful of stocks called the “Magnificent Seven” and pushing the grand average higher. (Goldman Sachs Global Investment Research)
The divergence between Wall Street’s biggest tech stocks and the rest of the S&P 500 (^GSPC) continues to widen, drawing comparisons to the inflated valuations of tech companies in the dot-com era.
The Magnificent Seven tech stocks, coined by Bank of America analyst Michael Hartnett, consist of Apple (AAPL), Alphabet (GOOGL, GOOG), Microsoft (MSFT), Amazon (AMZN), Meta (META), Tesla (TSLA), and Nvidia (NVDA). They operate in hardware and software, artificial intelligence and cloud computing and are seen by investors as powerful engines of new technologies that drive the economy and impact the lives of billions of people.
Overall, they are up 80% this year. And if you take them out of S&P growth, the rest of the index remains essentially unchanged, according to an analysis by Torsten Slok, chief economist at Apollo Global Management.
“AI is the latest shiny new toy,” Slok said of Wall Street’s enthusiasm for the growth of the Magnificent Seven, whose valuations are starting to resemble those of the 2000 tech bubble. The seven companies have an average P/E ratio above 50. The average ratio of the top performers during the dot-com crash was 63. (Disclosure: Apollo is the parent company of Yahoo.)
The story goes on
Driven by a wave of cost cuts and hype about AI’s transformative potential, valuations have skyrocketed as investors cheer the AI-led stock rally. The mega-cap stocks trade at significant premiums to the rest of the market.
Because of the Magnificent Seven’s outsized role on Wall Street, a possible downturn poses great risk.
“These seven companies have grown so large that millions of investors have stakes in them – whether they realize it or not,” said George Schultze, founder and managing member of Schultze Asset Management. “A correction in their share prices could have far-reaching implications for investors around the world.”
While superficial similarities warrant attention, analysts also say there are significant differences between the dot-com bubble of 2000 and the rise of the Magnificent Seven. The focus is on the basics.
“The current high-flyers have higher profit margins, faster growth and healthier balance sheets than their predecessors, which helps justify their higher valuations relative to the rest of the market and positive earnings momentum,” Tanenbaum said.
Team Crash: Former New York City Mayor Rudy Giuliani speaks to the Pets.com sock puppet during an event celebrating the 2002 release of the 20th anniversary edition of the board game Trivial Pursuit. (Keith Bedford/Getty Images) (Keith Bedford via Getty Images)
Looking at the financials of highly profitable companies like Apple and now-defunct ’90s darlings like Pets.com provides a striking contrast, she said. Back then, startups with unproven business plans commanded multibillion-dollar market valuations. Currently, technology giants have firmly established themselves in the global economy and operate across sectors.
Another fundamental difference between the two eras is the context of market trading. Some of the increases that investors saw in 2023 arguably represented a reversal of the sharp decline that mega-cap tech experienced in 2022.
And even if there is a decline, the market can still offer strong returns if its leaders lose momentum.
The S&P has returned an average of more than 14% annually since 1990, after the relative performance of its 10 largest stocks peaked, according to a new analysis from BMO Capital Markets led by Brian Belski. With a handful of mega-cap stocks on track to have one of their best years compared to the hundreds of other companies in the index, it’s unlikely that trend can continue next year. “Smaller” is likely to be a key investment theme in the coming quarters, the co-authors argue in their market outlook for 2024.
Since many of the biggest stocks that drove performance are unlikely to maintain the same momentum in 2024, investors will be forced to “look for other opportunities further down the market cap spectrum,” they wrote.
At the moment the party is still raging, even if some are urging caution.
“As with any stock that has experienced significant gains over an extended period of time, there is a risk of mean reversion, where a stock’s price declines to more normalized or average levels,” said Jason Betz, a private wealth advisor at Ameriprise Financial.
“No stock,” he added, “performs consistently better.”
Hamza Shaban is a reporter for Yahoo Finance covering markets and economics. Follow Hamza on Twitter @hshaban.
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