Crunch week this week and next, as the six of the so-called “Magnificent Seven” stocks – Apple, Microsoft, Alphabet, Amazon, Nvidia, and Meta Platforms – release their latest quarterly figures.
Tesla released its results last week and didn’t impress – a 44% slide in earnings from a year ago saw a 15% slump in the share price, especially CEO Elon Musk, who went all gloomy and distracted in an investor briefing call.
Investors are now hoping the weak reception for Tesla will not reappear this week when a total of 160 S&P 500 companies, including 12 companies in the 30-stock Dow, are down to report.
The seven have been responsible for driving nearly all of the S&P 500’s 12% year-to-gain because of their outsized weighting in the index (At June 30, it was more than a 16% gain for the key index).
The so-called Seven have replaced the FAANG of a few years ago – Facebook (now Meta), Apple, Amazon, Netflix (excluded), Google (Now Alphabet).
It is doubtful that any of the Seven will manage to match the 16% plus surge in Netflix’s price on Thursday, the day after its quarterly report last week. And how many will match Tesla’s 15% slide by Friday after its unimpressive 3rd quarter report earlier in the week?
But ignoring Netflix, valuations have surged to the point where the Magnificent Seven are trading at an average forward price-to-earnings ratio of 33.5, compared with the S&P 500’s P/E of 18.3.
At the same time, Treasury yields are at 16-year highs near 5% for the 10-year T-bond and are providing real investment competition to stocks. With government bonds offering risk-free yields around 5% or more, investors will be less forgiving of companies that are unable to deliver strong results.
“Everybody knows these guys are going to make money,” said Sameer Samana, senior global market strategist at the Wells Fargo Investment Institute (WFII), referring to the Magnificent Seven. “The only question is how fast is that earnings growth, and have investors overpaid for it,” Reuters reported.
The Wells Fargo Investment Institute in June downgraded its rating on the information technology sector – which includes Apple, Microsoft, and Nvidia – to “neutral” from “favorable.”
Results from Microsoft, Google-parent Alphabet, Amazon, and Facebook-parent Meta are expected next week, while Apple and Nvidia are set to report in early November.
In aggregate, the megacap companies are expected to post a 32.8% gain in earnings in 2023, while the rest of the S&P 500 sees a 2.3% decline, according to LSEG.
But the question is – after the surge in the first six months of the year, can the Big Seven produce the earnings and the outlooks to justify their high valuations?
Complicating the outlook is the relentless climb in interest rates and Treasury yields, driven by a mix of Federal Reserve hawkishness in the face of a strong economy and worries over the U.S. fiscal picture.
Growth and tech companies are seen as being more vulnerable to higher yields, as their typically robust projected future cash flows are valued less highly when investors can earn more from risk-free government bonds.
The yield on the benchmark 10-year US Treasury recently stood at 4.94%, its highest since July 2007.
“People have got choices that they didn’t have, and they will allocate differently,” said Tim Pagliara, chairman and chief investment officer at CapWealth. “The reallocation of funds going forward is going to suggest lower returns and more difficulty for the Magnificent Seven to maintain their leadership.”
CapWealth holds Microsoft shares and below-benchmark positions in Apple and Amazon, Pagliara said.
Tesla CEO Elon Musk said on Wednesday that he was concerned about the impact of high interest rates on car buyers.
The megacaps’ outperformance this year means their market heft has also grown. The seven companies’ combined market capitalization topped 30% of the S&P 500’s overall market value earlier this month, according to LSEG Datastream.
More than a third of fund managers named “long big tech” as the most crowded trade, according to BofA Global Research’s monthly survey published this week.
“Returns this year in the S&P 500 have been driven entirely by returns in the seven biggest stocks, and these seven stocks have become more and more overvalued,” Torsten Slok, chief economist at Apollo Global Management, said in a note.
As well as the Seven, others to report include Visa Inc, Coca-Cola Co, General Electric, Facebook parent Meta Platforms, IBM, Boeing, Automatic Data Processing, Mastercard, Merck & Co, Intel Corp, United Parcel Service, Exxon Mobil, and Chevron (both on Friday).