Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 554

History isn't on the side of the Magnificent Seven

Throughout 2023 and into this year, we have seen the performance of indices such as the MSCI World and the S&P 500 being driven primarily by a handful of mega-cap US names, almost exclusively within the technology space. What are the implications of this, and does it really matter?

Firstly, we need to zoom out a little and look at today’s concentration in the context of history to really understand whether what we’re witnessing today is really out of the ordinary.

What history says on the matter

As we can see from Figure 1, we’re at levels now in the US last seen during the ’Nifty Fifty’ era of the early 1970s. For those who were not present during that time (I, for one), the Nifty Fifty was a term used to describe a collection of blue-chip stocks in the US that were touted to be ‘one decision’ (i.e. you would just buy and hold these stocks, period). These stocks were so well loved that their valuations become quite stretched. However, from around 1973 onwards, these stocks cratered and went on to underperform the broader equity market. Since then, we’ve never seen the top five companies in the USA command a 25% market share of the US equity market – until now.

Figure 1. Share of top five companies by market cap in S&P 500: 1966 – 2023
Top five annotated through history


Source: DB Asset Allocation, Deutsche Bank.

Today, we’re seeing similar enthusiasm levels for the top end of the market, the so-called ‘Magnificent Seven’. Granted, the starting point in terms of valuations for the Magnificent Seven today is much less than the Nifty Fifty that preceded them.  Time will tell whether this will be enough to spare them a similar fate in terms of underperforming future equity returns.

The table below looks at the top 10 largest stocks in the world, at the start of each decade.

Table 1. The world’s 10 largest companies by market capitalisation (ex Berkshire and Aramco)


*Merged entities. Source: Gavekal Data/Macrobond

The first thing that stands out is how the composition radically changes over time. Each decade tends to be dominated by a big theme, and the stocks at the top of the list tend to reflect that. In the 1980s it was oil, and six of the top 10 were in the broader oil industry. In 1990, it was Japan’s seemingly unstoppable rise,  and eight of the largest 10 stocks in the world were Japanese. In 2000, it was the dot.com bubble, and eight of the top 10 were from the TMT sector. A decade later, it was China’s turn to take over the world, and most companies in the top 10 (with perhaps the exception of Microsoft) were companies that were either Chinese, or exported a lot to China, and thereby China was a big source of growth.

Interestingly, each subsequent decade has only seen one or two names in its top 10 that were present in the previous decade’s top 10. This highlights the lack of persistency in being able to remain a top performer for long stretches of time.

What happens if you hold the most dominant stocks?

So, what if an investor had, at the start of each decade, created a portfolio for themselves comprised entirely of the most dominant stocks of the time? I went through this hypothetical exercise myself.

I took the 10 largest stocks of each decade from the previous chart, calculated their subsequent returns for the following decade (e.g. the 1980 cohort had its performance calculated from 1 January 1980 to 1 January 1990), and created a simple, equal-weighted portfolio. I then compared this to the returns delivered by the MSCI World Index for the same subsequent time period.

Figure 2. Cumulative returns over the subsequent decade


Source: Fidelity International

In all but the 2010 vintage, our investor would have underperformed the broader market by investing in the mega-cap names of the time. And if we strip out Apple from the 2010 portfolio it, too, would have significantly underperformed the broader market. Apple delivered a cumulative return of almost 1100% from 2010 to 2020, vs the MSCI World of ~180%. If you missed Apple in 2010, then once again you would have been better off investing in the broader market.

Analysis from GMO, this time comparing investing in the largest 10 US stocks vs the rest of the S&P 500 shows that, on average, since 1957, you would have underperformed. However, since 2013, investing in the mega-caps has been a winning strategy. Whilst unusual, this is not unheard of – we witnessed similar episodes in the late 1960s/early 1970’s (Nifty Fifty era), as well as in the late 1990s (dot.com and internet bubble).

Figure 3. S&P 500: Top 10 vs 490 equal weighted


Source: Compustat, Standard & Poors

Figure 4. LTM profit ($US) of listed equities in G20 countries* by domicile, plus the Magnificent Seven and the seven largest stocks in Europe, for comparison


Source: Bloomberg Finance LP, Deutsche Bank. Note: aggregates are a sum of LTM net profit of common and preference stocks domiciled in a particular country, excluding stocks with a market cap below $200m.

Magnificent Seven: how big is big?

To be fair, most of the outperformance of the Magnificent Seven over the last decade has been driven by earnings. This has meant that, in aggregate, the NASDAQ is trading at cheaper valuations today than it did at the peak of the tech bubble in 1999. Said differently, valuation multiples for US mega-cap tech – whilst high relative to the broader market – can get to even more elevated levels than where they are today. If their amazing run of outperformance is to come to an end, it will need to come from future  earnings disappointing the lofty expectations that have  been set for them.

It’s worth keeping in mind that the Magnificent Seven are now more akin to countries, rather than companies, with respect to their sheer scale (see Figure 4). For example, Apple alone generates annual profits equivalent to over half of all French listed stocks (or German, for that matter), and more than the total profits generated by the entire Australian market.  In aggregate, the Magnificent Seven generate profits roughly equal to the entire Japanese stock market, or around half of the entire Chinese market.

So the question now is: Can companies the size of individual developed nations continue to grow at breakneck speed and, if so, for how long?

On top of the sheer element of size (law of large numbers is a headwind here), there’s also an element of circularity to this, as well. Nvidia has been by far the standout performer amongst the group in 2024. The revenues it generates in its Data Centre division (which accounts for ~80% of group revenues) is equivalent to ~40% of the cloud capex currently being spent by Amazon, Google, Meta and Microsoft combined.

Figure 5. Nvidia data center revenue as a percentage of Amazon/Google/Meta/Microsoft capex


Source: Platformonomics.com

Obviously, Nvidia is selling GPUs to more than just these four customers, and the total capex spend of this cohort of customers is going on not just GPUs, but a whole bunch of other things as well (think of CPUs, DRAM, NAND, network switches, etc.). But it nevertheless does highlight how Nvidia’s fortunes are closely tied to its fellow mega-cap brethren – and if one or more of this group of important customers needed to scale back cloud investment for whatever reason, it could have contagious effects.

The end of the reign of US mega-cap tech has been predicted for quite some time now, and to date that has proven to be incorrect. I’m not saying it’s game over for these guys from this point on, but I do think it’s prudent to think of other areas of the market that can also generate robust investor returns going forward and to diversify into them, given that history isn’t on the side of the Magnificent Seven.

 

Maroun Younes is Co-Portfolio Manager of the Fidelity Global Future Leaders Fund and Analyst at Fidelity International, a sponsor of Firstlinks. This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL 409340 (‘Fidelity Australia’), a member of the FIL Limited group of companies commonly known as Fidelity International. This document is intended as general information only. You should consider the relevant Product Disclosure Statement available on our website www.fidelity.com.au.

For more articles and papers from Fidelity, please click here.

© 2021 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.

 

RELATED ARTICLES

The 1970s offer a helpful framework for today's markets

banner

Most viewed in recent weeks

11 ASX dividend stocks for the next decade

What are the best stocks to own that can pay regular dividends and beat indices on a total return basis in the long-term? Here is our list of 11 ASX-listed companies that could help investors achieve these goals.

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

Time to smash the retirement nest egg - but how?

For decades, governments told people to save for retirement, then hold onto their nest eggs. Now, they're concerned that retirees aren't spending enough. How can we encourage reasonable spending patterns in retirement?

The greatest investor you’ve never heard of

Jim Simons has achieved breathtaking returns of 62% p.a. over 33 years, a track record like no other, yet he remains little known to the public. Here’s how he’s done it, and the lessons that can be applied to our own investing.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Latest Updates

Retirement

The challenges of retirement aren’t just financial

Debates about retirement tend to focus on the financial aspects: income, tax, estates, wills, and the like. Less attention is paid to the psychological challenges of retirement, which can often be more demanding.

Strategy

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Taxation

The mixed fortunes of tax reform in Australia, part 1

While there have been numerous tax reviews at the Commonwealth and state levels, most have not resulted directly in substantive tax reforms. This two-part series looks at that history and explores the pathway forward. 

Investment strategies

America, the world's new energy superpower

The US has become the world's new energy superpower, combining production, technology and capital in a way never previously achieved – a development sure to have global implications for decades to come.

Investment strategies

Could Korean corporate reform trigger a Japan-style market rally?

Corporate governance reforms in Japan have helped spur a 45% rise in the share market over the past 12 months. Korea looks set to follow the Japanese reform playbook, and may be poised for a similar bounce.

Property

How AI will transform the real estate sector

The real estate industry, traditionally characterised by its cautious adoption of new technologies, is now at a pivotal juncture. The emergence of AI promises to fundamentally change the way we live, work, and play.

Investment strategies

Charitable giving and tax deductions

With impending Stage 3 tax cuts incentivising taxpayers to bring forward future tax deductions while tax rates are higher, it’s a good time to explore how to bolster your tax savings and community impact through structured giving.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.