The Flyover:
In the last edition of Worth Considering, I discussed the phenomenon of “The Magnificent Seven”. This edition will provide an update and anticipated outcome.
Then there were Four. Or maybe even Three?
Last year every financial outlet, whether CNBC, Fox, or countless places online, had a field day with the nickname Magnificent Seven representing the small handful of mega-cap tech stocks that led the market.
It looks like the Magnificent Seven will soon be dubbed the Fab Four or the Tremendous Trio given the current weakness of some of these big winners from last year.
Let me make it very clear that this is good news for the markets overall.
As Apple, Alphabet (Google), and especially Tesla see their stock prices lag lately, the leadership of mega-cap tech is naturally wearing off. This brings the Magnificent Seven down to the Fab Four. And with Microsoft trending with the broader pack lately, some think it might be just a Tremendous Trio.
Whatever the case, this isn’t a story of deteriorating fundamentals or asset bubbles. This is a story of natural rotation.
The pace of this rotation is unknowable, and equally inevitable. As I alluded to in the last edition, these seasons of such outsized leadership are rare, but not unheard of. Just like seasons of nature, they are always temporary.
In the financial markets, history shows us that in past episodes of lopsided leadership, if those leaders were the smaller more speculative companies, things don’t end well. But when the leaders were more established larger companies that were essential to the daily lives of the general public, things ended just fine.
I don’t think there’s much of a debate that the components of the Magnificent Seven were more than just household names, but also household staples. When was the last day (not week or month, actual last day) that you or someone you know didn’t use a service from Apple, Amazon, Google or Facebook? While you may not own a Tesla, you sure see a lot of them in traffic. Since it’s clear that semiconductors are the modern-day lifeblood of technology, you can’t escape constant headlines about Nvidia, and I doubt there’s a business in the country not running at least one or more mission-critical programs from Microsoft at all times. It’s fair to say these companies create a solid representation of ‘a day in the life’ of Americana. They tell a good story, but none of this means their stock prices are immune from gravity. Common sense of valuation either prevails or fails. Fair value is either discovered or a bubble is created.
This is why rotation is so vital to the equation.
No doubt, leadership companies deserve premium valuations, but within reason. It is unreasonable to believe a short list of companies tells the entire tale of an economy or should be seen as the only names worthy of investment.
Ironically, when leadership are these large and integral companies, they actually create opportunities down the food chain. The cascading effect of strength moving downstream is strong. The simple fact that nothing cascades uphill explains why leadership from larger companies can resolve well, while leadership from the second tier ends with pain.
Indeed, this natural pull away from the market’s reliance on such a narrow list of stocks is a good thing. Market watchers have been waiting for it a long time.
To be clear, this season isn’t over just yet. The remaining 3 or 4 are still the big dogs. We are merely down from 7. It’s fair to say it looks like the long-awaited rotation is close to coming to fruition, but it would be unfair to say it is genuinely entrenched. As I write this, all the equal-weighted indexes are still mildly behind the cap-weighted indexes which means the mega cap names are still out front. But the gap is shrinking as the biggest names cool off and the mid and small stocks start to point in the right direction.
Some more good news here is that history suggests that when this next season of broader market participation takes hold, it’ll last a while. When there is no clearly discernable leading group, markets have a habit of doing very well and even for an extended period of time.
Nonetheless, let’s not get ahead of ourselves. We need to remember that markets have a well-established history of experiencing 3 or more corrections every year. This means pull backs of 5-10% are regular occurrences.
There’s no reason to think 2024 is a special year that won’t have a couple of these sharp corrections in store. Truth is, it needs to have them. Further, I wouldn’t be surprised if one comes our way relatively soon and I actually hope it does.
The reason is simply that corrections act as guards against bubbles.
It’s difficult to understand why investors get overly excited about garden variety corrections when it’s logical to assume they understood the lay of the land when they entered the markets. Everyone knows volatility is natural and even healthy, so why all the overreaction?
The answer, of course, is our human emotion that worries about losing everything we’ve worked for. Then comes the profit hungry media to prey on these emotions. When the cycle repeats itself yet again, speculators make the same silly statements about how the markets are somehow rigged. Meanwhile, investors who had the proper discipline and perspective realize that what’s rigged are our emotions and not the markets themselves, despite the latest Hollywood sensationalism of some bad actor or the current internet trope claiming yet another misguided death of capitalism or end of America.
The reason I labor this point is that we all need to be prepared for the correction(s) that come each year. As we near retirement, for example, we need to gradually shift our allocations to reflect that shorter time horizon and the possible distributions that come with slowing down at work. But while we still have plenty of time on our side, we might not need to shift anything more than our mindset about how to stay the course for our best future interests.
Little to no money is lost in a correction if investors maintain their perspective. Bubbles, however, pop recklessly and jolt the market ecosystem as a whole.
Whenever this next correction comes, it is unlikely to shake the foundations of the economy. It’s likely to be all about a pause in a trend that has seen markets rise quite a bit in recent months. It will just be another healthy pause, in my opinion.
Think of this next correction like a wave that comes ashore and churns the sand as it draws its way back to the ocean. Very natural and only dangerous if you weren’t paying attention.
In this analogy, think of the cleared sand as a change in leadership. The wave might knock over the existing sandcastles, but it leaves behind fertile ground for the next development. Specifically in this case, the past leadership of the Magnificent Seven will likely be exchanged for a broader market with literally hundreds of opportunities for others to play catch up.
The Takeaways:
- The sun is setting on the Magnificent Seven. That’s a good thing. It’s a changing of the guard more than the end of an era. Those companies aren’t going away, and their stocks don’t need to be avoided.
- The inevitable rotation to recognize the value of other companies may be just getting started. After an extended period of such clear leadership, it’s a long path back to normalcy, so this underlying trend of healthy rotation within the market is likely to be a tone for quite some time.
- There may be a necessary period of correction headed our way to put this rotation trend into place. The market’s upward history isn’t a straight line and those saw-toothed days on the charts are scary if you’re not emotionally prepared for them.
- As always, please don’t hesitate to reach out to us at any time you’d like to explore how these things might impact your life. We’d love to help in any way possible. That’s why we’re here!
Disclosure
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