This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Every investor knows the "Magnificent Seven" stocks. But did you know that the group name was more of a warning than a compliment? These days, the downsides envisioned by Bank of America executive Michael Hartnett are clearer than ever.
What are the Magnificent Seven stocks?
This group of tech giants has controlled the value of the S&P 500 (SNPINDEX: ^GSPC) index over the last two years.
I came up with a handy mnemonic to keep track of the seven components shortly after Hartnett started using the Magnificent Seven name in May 2023. "MAMA ANT" didn't catch on, but it still works for me. First, you have the four software companies:
- Microsoft (NASDAQ: MSFT)
- Amazon (NASDAQ: AMZN)
- Meta Platforms (NASDAQ: META)
- Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL)
Then you have the three hardware stocks:
- Apple (NASDAQ: AAPL)
- Nvidia (NASDAQ: NVDA)
- Tesla (NASDAQ: TSLA)
Easy enough, right? These six artificial intelligence (AI) experts and one pioneer in electric vehicles are shaping the stock market.
Fast-forward to November 2024, and you'll still find these seven companies at the very top of the market. They were among the 10 largest American stocks by market cap in the spring of 2023. By now, they have simply become the top 7. Only two Magnificent Seven stocks -- Microsoft and Apple -- have underperformed the S&P 500 since May of last year. The others have soared, pushing the cap-weighted index higher as a result.
What's the downside to this group of massive market-beaters?
From the vantage point of May 2023, Hartnett outlined several risks related to the Magnificent Seven stocks.
- He expected the federal funds interest rate to rise above 4% (from 0.8% at the time) amid last year's inflation-fighting efforts. In reality, the rate shot up to 5.3% three months later.
- The tech giant group accounted for nearly all of the leading market index gains in early 2023. Nearly half of the S&P 500 stocks lost value that spring, while Nvidia and Meta Platforms doubled.
- These stocks were already large when the AI boom started. Therefore, they have outsize effects on market indexes whose values are weighted by market capitalization -- such as the S&P 500 and Nasdaq Composite. The Magnificent Seven currently accounts for 32.2% of the S&P 500 index score. That's up from 27.3% in May 2023 and 20.1% at the end of 2022. Hartnett saw market risks in this skewed structure, leaning heavily on a small group of market-defining stocks.
- Hartnett talked about a "baby bubble" around AI in 2023. If he got anything wrong, this is probably it. AI is either a true game-changer and long-lasting macro trend or the largest market bubble in history. There's nothing "baby" about it anymore, either way.
Michael Hartnett identified an important stock grouping fairly early and gave it a catchy name. He could have picked many other titles but chose a classic Western movie with a tragic ending. Alternative monikers could have been "seven deadly sins" or "seven plagues" but not "seven wonders of the world" or "seven colours of the rainbow."
In the Yul Brynner and Steve McQueen movie, only three of the Magnificent Seven gunfighters survive the final battle. That's the metaphor Hartnett selected. I'm not saying that the big winners of the AI boom are doomed right now, but investors should keep an eye on potentially overheated valuations in this space.
This grouping was meant as a warning, not an investment recommendation.
How to handle the Magnificent Seven stocks today
The average S&P 500 stock is valued at 28.7 times price-to-earnings (P/E) and 23.6 times price-to-cash reserves (P/C). Alphabet and Meta Platforms stand out as reasonably priced AI giants, while Tesla and Nvidia look painfully expensive:
| Magnificent Seven Stock | P/E Ratio | P/C Ratio | Market Cap |
|---|---|---|---|
| Alphabet | 23.7 | 23.2 | $2.16 trillion |
| Meta Platforms | 27.8 | 28.4 | $1.48 trillion |
| Tesla | 88.0 | 32.7 | $1.11 trillion |
| Nvidia | 69.3 | 103.2 | $3.59 trillion |
Data source: Finviz.com on Nov. 9, 2024. P/E Ratio = price-to-earnings ratio. P/C Ratio = price-to-cash ratio.
Meanwhile, the leading market indicators rely on these seven samurai to an extraordinary degree, and their importance is only rising. If a company like Nvidia or Microsoft runs into unexpected trouble, that event will move the stock market as a whole. That's the nightmare scenario Michael Hartnett wanted to caution his clients about 18 months ago.
Pick your investments carefully, even in hot sectors like AI and electric vehicles. Diversification will help you survive any market calamity and build wealth in the long run. And that's the point Michael Hartnett was making with his Magnificent Seven metaphor last year -- this bundle of soaring giants looked good in the spring of 2023 (and still does today), but they might hurt your portfolio someday.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
