HUB EXCLUSIVES PANEL DISCUSSION – MAGNIFICENT SEVEN OR BUST?
Panel discussion, hosted by Cherry Reynard, with:
Anjli Shah, Investment Director, abrdn
Hugh Grieves, Fund Manager, Premier Miton Investors
Joseph Knight, Investment Director, Ninety One
In 2023, US stock markets were led by a handful of fast-growing technology companies, considered likely to benefit from a revolution in artificial intelligence. However, as the realities – and cost - of AI adoption have become clearer, investors have reappraised the ‘magnificent seven’ and other parts of the market have started to revive. Investors have grown used to relying on index funds to do the heavy lifting in US markets, but a change in approach may be needed to capture growth from here.
Joseph Knight, portfolio specialist at Ninety One, says the ‘Magnificent Seven’ was never an homogenous group and their fortunes are now starting to diverge significantly. Nvidia and Microsoft has pulled away from the rest, while Apple and, in particular, Tesla, have weakened. Knight says: “Five of these companies fulfil our quality criteria and, at the moment, we hold two of those – Alphabet and Microsoft. Two fall outside our investment parameters – Tesla and Amazon. This is because of the cyclicality embedded in their business models, and their capital intensity.
He believes the two businesses they hold are in a good position to benefit from AI. He adds: “If 2023 was about the AI dream, it is now about who can monitise it. Microsoft can embed AI into product and services and it has real benefits for Azure. For Alphabet, it should help compound its dominance in search.”
Nvidia has continued to grow ahead of even the elevated expectations set for it by the market. It has outpaced all of the remaining seven since the start of the year. However, Knight says it is getting harder to get confidence in the long-term trajectory of its core business in data centres. “When we weigh that up against other risks to investment case, we prefer to deploy capital elsewhere. That’s not necessarily the same as saying it’s not going to be strong, but from our perspective, we think Microsoft is likely to be the market leader.”
Weakening revenue growth
Hugh Grieves, manager on the Premier Miton US Opportunities fund, points out that many of these companies are not growing at the pace they were a few years ago. He adds: “Putting Nvidia to one side, the average revenue growth for the other six has been significantly lower than it was just a couple of years ago. These are now mature businesses - Apple didn’t grow its revenues at all last year and the market for EVs is undergoing a rethink.
“Facebook and Amazon are going through some cost-cutting, which leaves Nvidia and Microsoft. And there the question is what you pay for it. There is a lot of expectation embedded in the valuations. Our view is that the other 493 companies in the S&P 500 look a lot more attractive than these seven which, let’s face it, everyone knows and everyone owns.”
Beyond the large caps
There is plenty of growth to be found beyond these dominant companies. Anjli Shah, investment director at Abrdn, says: “For the first time in two years, the Russell 2000 is forecast to have growth - about 12% this year and 29% next year. People wrongly assume that small and mid caps don’t contain AI winners, when in fact they do. The AI ecosystem is broadening out and we see a number of stocks that are also beneficiaries.” She points to Cadence and Synopsys, which Abrdn holds in its global mid and small cap portfolios. These companies provide simulation software for chip makers. They are growing very rapidly as the use cases for AI expand.
She adds: “There are a lot of stocks that are market leaders in their niches, that operate in areas of high structural growth, that have barriers to entry and are price setters rather than price takers.” She says that the market has started to recognise the value in these companies since the start of the year.
Valuations
Relative valuations for small and mid caps versus the rest of the market remain at extreme levels. Shah says that they are at their lowest level since the mid-1990s and the market is discounting a lot of bad news. They are “a coiled spring”, she says.
Grieves says: “What we see for the forgotten 493 is decent earnings growth amid a decent economy. No-one rings the bell to say it’s over for the megacaps; there’s simply a gradual realisation that things have changed. Since November, the magnificent seven has stopped outperforming as a group. Eventually, we’ll stop having a conversation about this part of the market and it will become just another acronym we used to talk about.”
Knight says that the focus on the Magnificent Seven has led investors to overlook a lot of good opportunities and that is firmly where the opportunities lie today. He points out that 141 companies outperformed the S&P 500 in 2023: “No-one knows how the US economy is going to land, but there are a lot of high quality businesses that have shown real resilience, and eventually the market will start to recognise that.”
