What the Magnificent Seven can teach us about hindsight in investing

The seven biggest US technology giants, known as the Magnificent Seven, completely dominate global markets. While it might seem now as if their time at the top will go on and on, it’s important to remember that nothing lasts forever.... Read more

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Blog5th Mar 2024

By Tom La Dell

The seven biggest US technology giants, known as the Magnificent Seven, completely dominate global markets. While it might seem now as if their time at the top will go on and on, it’s important to remember that nothing lasts forever.

The big guns are dominant – but how long can it last?

The leading corporations, Apple, Alphabet (Google’s parent company), Amazon, Microsoft, Meta (owner of Facebook), Nvidia and Tesla have soared ahead of the pack in the last year. Their profits outstrip those of all other listed companies in almost every G20 country. If they were a stock exchange in their own right, only the US would be larger. [1]

We briefly touched on this group in our last blog post, looking at how their combined valuations greatly outweigh those of every other markets.

The question is, where do they go from here? Can they keep up the momentum? Some investors are certainly counting that these stocks will keep riding the crest of a wave.

The brutal truth is that this period is probably already over.

Rise and rise, or rise and fall?

Technology has dominated markets over the last decade. But, as this research from Dimensional shows, the Seven’s best may already be behind them.

Looking at annualised returns for the US market, the years before a company enters the top 10, are usually extremely fruitful for investors. At 10 years before entry, the average was 12.1% ahead of the average index returns. This increased to 27% ahead at three years before they entered. However, once these companies reach the top, things are less promising. Three years after a company entered the top 10 and annualised returns were only 0.6% ahead of the market, a decade on, they were 1.5% below.[2]

Graph showing annualised returns for the US market in the years before a company enters the top 10 compared to the years after joining the top 10 largest. Past performance is not a guarantee of future results.

The lesson is, once a company becomes a ‘mega-cap,’ you might not be able to rely on the big returns anymore.

A warning from history

Over the last few decades, market leadership has changed hands several times. As this animation looking at the S&P 500 between 1980 to 2020 shows, IBM, Exxon Mobil, General Electric, AT&T have all had their times at the very top. When they’re there, it’s very difficult to visualise them ever losing their spot, but none of them are in the top 10 now.

Looking back even further, in the ‘60s and early 70s, the major force was the ‘Nifty Fifty’, blue-chip stocks, including American Express, McDonald’s, Kodak and Coca-Cola, that investors believed would just keep growing. The bubble burst in the mid-1970s with big share-price falls (Kodak’s fell more than 90%). Some recovered, but investors no longer lauded them in the same way.

It’s also worth bearing in mind that while big companies do keep getting bigger (in 2007 saw the first trillion-dollar company, there are now seven), the average lifespan of a company is falling. According to McKinsey, In the mid-1930s, the average S&P 500 company would expect to last 90 years, today, this lifespan has shrunk to 18 years.

Diversification is better than hindsight

If you’d invested £1,000 in Apple in on 24 January 1984, when it launched its Mackintosh computer, you’d have close to £2 million today.[3] But betting that this company would go on to become one of the world’s largest would’ve been a major gamble – the kind that rarely comes off.

There’s a far less stressful and risky way to invest your money, one that doesn’t rely on being in exactly the right place and right time to come off – diversification.

Having a diversified portfolio helps avoid the trap of trying to second guess when a stock will start to lose its lustre, or watching to see if a particular kind of firm is back in fashion. These portfolios help you spread the risk by ensuring you’re not too concentrated in one region, and have a mixture of defensive stocks, that hold up better in times of economic stress, and cyclical ones, which are usually expected to do better when the economy is on the up.

Diversification is also about maximising your opportunity. Let’s not forget, there are plenty of well-run, profitable companies out there, operating across a variety of industries, and outside the US in Europe, the UK, Japan and in emerging markets. There’s more to life than the Magnificent Seven.

Want to find out more about how diversification can help you weather financial storms? Get in touch today.

 

[1] Magnificent 7 profits now exceed almost every country in the world. Should we be worried? (cnbc.com)

[2] Source: Dimensional. Based on annualised returns in excess of the US market before and after joining the largest US stocks. January 1927–December 2022. Market is defined as the Fama/French Total US Market Research index. Past performance is not a guarantee of future results.

[3] Source: Apple historical price data from Yahoo finance, 24 January 1984 to 28 February 2024.

By Tom La Dell

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