By Catriona Burns, WAM Global Lead Portfolio Manager
14 February 2024
In January, Microsoft joined Apple in achieving a $3 trillion valuation. These companies are two of the group that form “The Magnificent Seven”, that is, Apple (NASDAQ: APPL), Microsoft (NASDAQ: MSFT), Alphabet (NASDAQ: GOOG), Amazon (NASDAQ: AMZN), Nvidia (NASDAQ: NVDA), Meta (NASDAQ: META) and Tesla (NASDAQ: TSLA). Collectively, these companies achieved historic price appreciation in 2023, with returns exceeding 100% compared to the MSCI World Index’s 23% and the S&P500 Index’s 26%.
Whilst each company has its individual nuances, the Magnificent Seven’s remarkable performance in 2023 can be attributed to three defining characteristics – lower interest rate expectations, robust earnings growth and the pervasive excitement surrounding artificial intelligence (AI). Nvidia, for instance, experienced a 300% increase, primarily driven by its focus on graphics processing units (GPUs) related to AI technology. Likewise, Microsoft and Google have made significant strides with their AI products ChatGPT and Bard/Gemini, as well as with the co-pilots they are putting into their suites of products.
The allure of enormous stock market returns is natural but it is crucial that investors remain focused on an individual stock’s fundamentals, valuation and long-term earnings trajectories. Share price performance within the Magnificent Seven has seen wide dispersion in this regard. Within the group, Nvidia and Amazon’s share price rises have been accompanied by significant earnings growth. In the case of Nvidia, earnings per share are forecast to be up over 400% for the year ending 31 January 2024. The earnings path forward is less clear, but investing today requires an assumption that the demand profile continues to be robust. Others like Tesla and Apple have seen earnings come under pressure and growth expectations reduced. Microsoft and Google’s earnings growth has been solid but more than outpaced by the share price rises, indicating valuations are now more expensive.
Within the Magnificent Seven group of companies there are some very high quality businesses, but a great business does not always mean a great investment if the price paid is too high. Diversification, particularly in the small and mid-cap end of the market, becomes even more attractive when returns have been so concentrated of late, with the Magnificent Seven now making up nearly 30% of the S&P500 Index and being responsible for over 70% of the indices returns for the 2023 year.
The tech sector’s recent performance was partially influenced by expectations of declining interest rates. The Federal Reserve has done an admirable job of walking the path to a ‘soft landing’, but history tells us how difficult this is to achieve. If the Federal Reserve doesn’t cut rates as much as expected, this would create a valuation headwind for stocks particularly where the valuations have increased significantly. Unforeseen changes in interest rates expectations are always possible, as evidenced by the hawkish pivot in 2021/2022 and it is when other investors are least focused on valuation discipline that a prudent investor should place additional focus on this area.
Within the WAM Global (ASX: WGB) investment portfolio, we believe there are many ways to invest in AI outside of the Magnificent Seven, focusing on the value of platforms, distribution and proprietary data.
We own companies such as Intuit (NASDAQ: INTU), a tax software and accounting provider, which has unique data, strong distribution and clear opportunities for AI co-pilots; Intercontinental Exchange (NYSE: ICE), which has leveraged its market data with AI to provide real-time analytics; SAP (ETR: SAP) which is delivering valuable AI driven insights and automating tasks utilising valuable
company and sector data, and Booz Allen Hamilton (NYSE: BAH), which is a clear leader in its ability to provide AI solutions the US government. There are plenty of ways to play this dynamic at the small end of town, with valuations that are in many cases significantly less demanding.
AI is real, impactful and here to stay. In the last year, management teams need only mention ‘artificial intelligence’ in an earnings call to see share prices run higher. There will be companies where AI offers more hype than reality and who over time do not actually benefit from AI, nevertheless there are very exciting applications of this technology ahead acting as a secular tailwind for well-selected stocks.
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