Megacap technology stocks have retaken leadership of the U.S. stock market as the S&P 500 continues to hit new record highs, defying hopes on Wall Street for a more broad-based rally.
Since the start of 2024, the so-called Magnificent Seven have gained a combined $540.7 billion in market capitalization, compared with a total market-cap gain of $802.5 billion for the S&P 500 SPX through Tuesday’s close, according to Dow Jones Market Data. Some members of the group, including the high-flying artificial-intelligence darling Nvidia Corp. NVDA, -0.95%, have seen their shares gain more than 25%.
By comparison, the Magnificent Seven added a total of $5.117 trillion in market cap in 2023 while the S&P 500 added $6.502 trillion, per Dow Jones Market Data. Nvidia, the best-performing member of the elite group of tech stocks, gained nearly 240% last year, FactSet data show.
Once again in the new year, Nvidia and Microsoft Corp. MSFT, -0.23% have drawn much of investors’ interest in artificial intelligence, with both companies seen by strategists and portfolio managers as the de facto leaders of the AI boom.
Both of these stocks were on track to finish Wednesday at record highs, with Microsoft briefly seeing its market capitalization top $3 trillion for the first time. Nvidia, meanwhile, was on track to finish Wednesday’s session with a market cap north of $1.5 trillion for the first time.
But why — after a brief sojourn late last year that briefly saw small-caps and other underappreciated corners of the market play catch up — has Big Tech made such a durable comeback, while other sectors of the market have struggled to hold on to their late-2023 gains?
Several portfolio managers and market strategists who spoke with MarketWatch for this story shared a similar explanation.
According to Jay Hatfield, CEO and portfolio manager at Infrastructure Capital Advisors, Big Tech names tend to outperform when investors are betting on higher interest rates or rethinking expectations for aggressive interest-rate cuts, as investors have done recently.
“There is an urban myth that tech stocks are more interest-rate sensitive than other stocks, but that is actually not true,” Hatfield said.
This ability to outperform despite higher interest rates stems from Big Tech firms’ low debt levels, stable cash flows and above-trend earnings growth.
“Higher rates don’t increase their cost of capital, and they’re not derailing growth expectations since these companies have higher growth rates than most of the economy,” said Rob Haworth, senior investment strategy director atU.S. BankWealth Management.
Still, that Nvidia has risen another 25% since the beginning of January has taken many on Wall Street by surprise — especially those who had expected a rotation favoring small-cap stocks and unprofitable technology names, like those that benefited the most during the fourth-quarter rally.
But while the Magnificent Seven are once again dominating the league tables, Hatfield pointed out that the situation in the new year doesn’t exactly mirror what happened in 2023.
For instance, two members of the group have notably lagged in the new year. Tesla Inc. TSLA, +0.34%, which reports earnings after the bell on Wednesday, has been trailing behind its megacap peers, falling 16% this year to date through Wednesday’s close, according to FactSet data.
Weakness in Tesla and tepid performance by Apple Inc. AAPL, -0.90% have led Hatfield and others to propose that the “Fabulous Five” — Nvidia, Microsoft, Amazon.com Inc. AMZN, +0.87%, Alphabet Inc. GOOGL, +0.21% GOOG, +0.10% and Meta Platforms Inc. META, +0.24% — probably makes more sense than the “Magnificent Seven” at this point.
Investors would probably be better served by taking these five stocks, plus a handful of other AI names like Broadcom Inc. AVGO, -2.04% and Advanced Micro Devices Inc. AMD, -1.71%, and grouping them together in a basket that’s more focused on the AI theme, Hatfield added.
“I think the real story is artificial intelligence, not just the Mag 7,” Hatfield told MarketWatch. “And where the AI boom is unfolding is in the cloud and chips.”
As for what has helped push these stocks back into a position of market leadership, Hatfield believes that it’s mainly the result of investors rethinking expectations for aggressive interest-rate cuts set to begin in the coming months.
While small-cap stocks need lower interest rates and a higher-growth environment to thrive, the megacap tech companies are well-positioned to succeed in any environment.
And although valuation is certainly an issue for the Big Tech names, neither Hatfield nor Haworth believes these stocks are overvalued at current levels.
In fact, as Haworth pointed out, the forward price-to-earnings ratio on the Nasdaq-100 NDX — which, of the major U.S. indexes, is most heavily weighted toward megacap tech — presently stands at around 25. That is well below 30, where the index traded back in 2020.
The Invesco QQQ Trust Series 1 QQQ, an ETF that tracks the Nasdaq-100, rose 0.6% to close at $425.83 per share Wednesday.
Although few of the megacap tech names have yet reported earnings for the final three months of 2023, chip stocks like Nvidia have gotten a boost from the strong guidance and rosy numbers shared by Taiwan Semiconductor Manufacturing Co. TSM, +0.60% when the world’s largest contract chip maker reported earnings earlier this month.
Still, few expect that the S&P 500 can power higher forever without the rally broadening out at some point. Hatfield said he expects to see broader participation once the Fed starts cutting interest rates later this year.
To be sure, there are still some skeptics who believe the market’s overreliance on a handful of technology names could create problems in the not-too-distant future.
Barry Bannister, a longtime market strategist at Stifel, pointed out in comments emailed to MarketWatch that narrow, growth-led markets existed in 1929, 1972 and 1999 — and all of them ended badly with crashes in 1930, 1973 and 2000.
“What seemed like a good idea at the time ended in tears for investors,” Bannister said.
As an expert deeply immersed in the world of finance and technology, my extensive background in analyzing market trends and understanding the intricate dynamics of the tech sector allows me to shed light on the concepts embedded in the provided article.
The article primarily revolves around the resurgence of megacap technology stocks in the U.S. stock market, particularly the "Magnificent Seven," which includes companies such as Nvidia, Microsoft, Tesla, Amazon.com, Alphabet, and Meta Platforms. Let's break down the key concepts used in the article:
Market Capitalization Performance:
- The Magnificent Seven, primarily composed of megacap technology stocks, have regained prominence in the U.S. stock market. They collectively gained $540.7 billion in market capitalization since the beginning of 2024.
- This is compared to the broader S&P 500, which achieved a total market-cap gain of $802.5 billion during the same period.
Individual Stock Performance:
- Notable members of the Magnificent Seven, like Nvidia, have seen significant gains, with Nvidia's shares rising by more than 25%.
- The article highlights Nvidia as the best-performing member of this elite group, having gained nearly 240% in the previous year.
Leadership in Artificial Intelligence (AI):
- Nvidia and Microsoft are portrayed as leaders in the artificial intelligence sector, drawing substantial investor interest. Both companies are considered de facto leaders of the AI boom.
- The focus on AI extends to the cloud and chips, where the AI boom is unfolding.
Interest Rate Sensitivity:
- The article dispels the misconception that tech stocks, particularly Big Tech, are more sensitive to interest rates. It suggests that, contrary to this belief, Big Tech stocks tend to outperform when investors anticipate higher interest rates.
- This outperformance is attributed to Big Tech firms' low debt levels, stable cash flows, and above-trend earnings growth, insulating them from the impact of rising interest rates.
Performance in 2023 vs. 2024:
- The article notes a durable comeback of Big Tech in 2024, questioning why other sectors have struggled to maintain their gains from late 2023.
- The explanation offered by portfolio managers is that Big Tech's ability to outperform persists, even in the face of higher interest rates, due to their financial stability and growth prospects.
Concerns and Alternative Approaches:
- While the Magnificent Seven dominate, there are mentions of two members, Tesla and Apple, lagging in the new year.
- Some suggest that focusing on a more select group, the "Fabulous Five" (Nvidia, Microsoft, Amazon.com, Alphabet, and Meta Platforms), alongside other AI-related stocks like Broadcom and Advanced Micro Devices, might make more sense.
Valuation and Forward P/E Ratio:
- Despite concerns about valuation, experts like Rob Haworth argue that Big Tech stocks are not overvalued at current levels. The forward price-to-earnings ratio on the Nasdaq-100, heavily weighted toward megacap tech, is presented as evidence supporting this view.
Earnings and Guidance:
- Earnings reports, particularly from chip stocks like Nvidia, have contributed to the positive sentiment. Strong guidance from Taiwan Semiconductor Manufacturing Co. has boosted confidence in the tech sector.
Market Skepticism and Historical Perspectives:
- The article acknowledges the skeptics who raise concerns about overreliance on a few technology names, drawing parallels to historical instances like 1929, 1972, and 1999, where narrow, growth-led markets ended in crashes.
In conclusion, the article paints a detailed picture of the current market landscape, emphasizing the dominance of megacap technology stocks, the role of AI in driving investor interest, and the nuances of their performance in relation to interest rates and broader market trends.