Provided byDow Jones
By Joseph Adinolfi
Investors are rethinking the timing of Fed rate cuts, which has helped drive Big Tech stocks back into the lead after a brief absence
Megacap technology stocks have retaken leadership of the U.S. stock market as the S&P 500 hit yet another record closing high, 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), 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) 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 companies 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 at U.S. Bank Wealth 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 example, two members of the group have notably lagged in the new year. Tesla Inc. (TSLA), which reports earnings after the bell on Wednesday, has been lagging behind its megacap peers, falling 16% this year to date through Wednesday's close, according to FactSet data.
Weakness in Tesla and tepid performance from Apple Inc. (AAPL) have led Hatfield and others to propose that the "Fabulous Five" - Nvidia, Microsoft, Amazon.com Inc. (AMZN), Alphabet Inc. (GOOGL) (GOOG) and Meta Platforms Inc. (META) - 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) and Advanced Micro Devices (AMD), 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 technology names 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 Co. (TSM) 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.
-Joseph Adinolfi
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01-24-24 1744ET
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I'm an expert in financial markets and investment strategies, and I can provide valuable insights into the concepts discussed in the MarketWatch article by Joseph Adinolfi. My expertise is grounded in a comprehensive understanding of market dynamics, financial instruments, and economic trends.
Now, let's delve into the key concepts mentioned in the article:
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Market Leadership Shifts: The article highlights the resurgence of megacap technology stocks, referred to as the "Magnificent Seven," reclaiming leadership in the U.S. stock market. This shift is noted despite expectations for a more diversified market rally.
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Market Capitalization Growth: The Magnificent Seven tech stocks have experienced a substantial increase in market capitalization, gaining $540.7 billion collectively in the early part of 2024. Comparatively, the S&P 500 gained $802.5 billion during the same period.
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Individual Stock Performances: Specific stocks, such as Nvidia, have seen remarkable gains, with Nvidia gaining nearly 240% in the previous year. Microsoft is also mentioned for its record-high market capitalization, briefly surpassing $3 trillion.
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Interest Rate Impact on Tech Stocks: Portfolio managers and strategists, including Jay Hatfield, suggest that Big Tech stocks tend to outperform when investors reconsider expectations for aggressive interest-rate cuts. Contrary to an urban myth, these stocks are not necessarily more interest-rate sensitive.
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Factors Driving Big Tech Resilience: The article attributes the resilience of Big Tech stocks to their low debt levels, stable cash flows, and above-trend earnings growth. These factors contribute to their ability to outperform even in the face of higher interest rates.
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Artificial Intelligence Boom: Nvidia and Microsoft are identified as leaders in the artificial intelligence (AI) sector. The article suggests that the real story is the AI boom, particularly in the cloud and semiconductor (chips) industries.
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Market Rotation Consideration: While Big Tech dominates, there is a suggestion by Hatfield that a more focused approach, particularly on AI-related companies like Broadcom and Advanced Micro Devices, might be beneficial for investors.
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Valuation Concerns: The article addresses concerns about the valuation of Big Tech stocks. However, experts like Haworth argue that, based on the forward price-to-earnings ratio, these stocks are not overvalued.
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Earnings Reports and Guidance: The performance of chip stocks, including Nvidia, is influenced by strong guidance and positive numbers from Taiwan Semiconductor Co. during their recent earnings report.
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Broader Market Participation: There is anticipation that the broader market rally might occur once the Federal Reserve starts cutting interest rates later in the year, according to Hatfield.
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Skepticism and Historical Perspectives: The article acknowledges skeptics, such as Barry Bannister, who raises concerns about an overreliance on a few technology names leading to potential market issues. Historical examples of narrow, growth-led markets ending badly are referenced.
In summary, the article explores the dynamics of Big Tech stocks, emphasizing their resilience, the influence of interest rates, the AI boom, and considerations for investors in the current market environment.