Article

The 'Magnificent Seven' are not riding off into the sunset yet

The potential for new artificial intelligence products boosted the valuations of seven of the largest US-listed technology groups last year.

| 8 min read

Technology shares were hard hit by the bear market of 2022. Many investors had taken some profits from their holdings of the faster-growing technology darlings of lockdown as circumstances changed.

Lower valuations occurred as interest rates rose

Commentators argued that higher interest rates would slow growth and make the future earnings of these glamour stocks less valuable.

At the end of 2022, we argued that equities should do better in 2023, with the digital space offering plenty of opportunity. This was based on the fact we expected the world would continue to build more elaborate social media, data handling, automated factories, downloaded entertainment, online retailing, artificial intelligence, electronic learning – and many other areas subject to the digital transformation.

In February last year, Chat GPT made its big announcement that it will provide enhanced search or artificial intelligence (AI) as a service. We wrote enthusiastically that this would be stardust on the shares of companies able to exploit this new advance.

The big technology companies are now in a race to develop new and enhanced services based on these developments. Computers can now analyse large data sets and use the conclusions to exercise some decision-making ability under the control of software that uses data storage and retrieval systems that are based in the cloud. We were soon hearing of the companies that markets expected to benefit from these technological advances. Out went references to the FANG stocks of lockdown fame (Facebook, Amazon, Netflix and Google) – and in came references to the ‘Magnificent Seven’.

Market participants focused on Apple, Amazon, Alphabet, Microsoft, Nvidia and Meta Platforms – which are all looking at the new opportunities of the digital revolution. Tesla was also included in this new set of market darlings as the business is developing new electric cars fitted with significantly more control technology.

All these equities soared in 2023. The companies are seven of the top nine companies in the MSCI World Index and dominate the S&P 500 and Nasdaq indices in the US. All the top nine companies in this equity index are American, with Broadcom, another technology company, and Morgan Chase making up the nine.

The Magnificent Seven share price gains in 2023

Apple48.2%
Microsoft56.8%
Alphabet58.3%
Amazon80.9%
Tesla101.7%
Meta Platforms194.1%

Nvidia

238.9%

Can the Magnificent Seven deliver more?

There have been various worries about how sustainable this is. It is most unusual for one country, however large and important, to be so ahead. It is even more unusual for one cluster of industries to be so dominant.

In previous decades large oil and energy companies, large banks and financial businesses, large industrial businesses and big pharmaceutical companies have often been represented in the top ten names in the MSCI World Index. There has usually been some representation from Japan or Europe. Bears of the current trend have been doubting the ability of the technology giants to grow their revenues and profits in the way market valuations imply.

Bulls of other sectors have been pointing to the favourable impact higher interest rates should have on banks and some financial businesses, on how the higher energy prices should bolster energy company returns, on how Covid-19 and the obesity wave should boost pharmaceutical earnings, and how industrial activities in advanced countries might benefit from the big move to onshoring. So far, these arguments have not been persuasive enough to change the top rankings in the MSCI World Index.

Indeed, 2023 saw the Magnificent Seven become even more dominant.

Rising demand for digital technology

The bull case has rested on the way the main technology giants have gained a stronghold over consumers and business customers.

  • Microsoft is the preferred software supplier of so many firms and homes. As it enhances its AI offering so it will be able to provide more and charge more to the many businesses where it has become the co-pilot sitting alongside employees at their desks.
  • As Google sees challenges to its position in searches sustained by advertising revenue, it too is looking to enhance its offer to encompass intelligent search and report writing to provide it with another revenue stream.
  • As Amazon builds its own technology for Amazon Web Services it can extend its range from providing plenty of data storage into more help with processing as AI is rolled out.
  • Nvidia retains its dominant position in the smart microprocessors which will be needed in huge numbers to provide the capacity individuals and businesses need in their smartphones and other devices. It is difficult to see a future without these companies or their successors being more and more involved in business activity and consumer service – and finding ways to remunerate their shareholders.
  • Apple has retained considerable sway over consumers in the provision of pads and phones, and in some of the services that these devices can offer consumers. It has difficult issues in its relationship with China, both as a market for its products and as a manufacturing centre for what it offers. Tesla has attached itself to the Magnificent Seven, though it is somewhat different. Its success to date has come from providing upmarket electric cars to a segment of the car market where the traditional suppliers have not been quick enough off the mark to deliver sufficient attractive product. It is true
  • Tesla is also working on a lot of additional car technology to make their vehicles more automated. It will also face more competition as prices come down and the marketplace widens.
  • Meta Platforms is getting into AI as an adjunct to its social media positioning, as it is very dependent on advertising on its media platforms. These three are not so bound into the AI business enhancing revolution as the other four.

Another good year?

It seems unlikely the technology sector can have another year as good as 2023 as we enter 2024. There will be some strong competition between the three leaders of the AI revolution – Amazon, Microsoft and Alphabet. There will be additional free services and discount offers as they expand their range and grip on businesses and consumers alike to increase their dependence on internet-based technology.

There will be some good profits performance in some other sectors as interest rates are brought down later in 2024, and as governments and central banks turn more attention to growth as inflation subsides.

The business models of Apple in China, of Meta with its reliance on advertising and Tesla with the likelihood of more competition to come may be tested more than the three giants of the AI world and data processing. The business models of many other companies and sectors will also be challenged by the AI revolution, as they seek to adapt to more being done online and more being carried out by computers. The digital revolution has already had a huge impact on areas as diverse as media, music and entertainment, shopping, communications and office working.

There is much more to come. Analysts need to ask the AI question of most major companies to see how they can use it without losing crucial business opportunities. In 2024, many portfolios will still want some exposure to the all-pervasive presence and continuing growth of the digital revolution. The steady increase in business sharing by the majors and in the build-up of their cloud-computing capacity, AI and general service revenues underwrites a lot of the share price performance.

Investors, however, may need to become more discerning over which companies will have what it takes to develop those opportunities in a profitable enough way. The equity-market ratings now expect quite a lot after their 2023 recovery. Any failure to translate this new business opportunity into good corporate cashflow could worry markets significantly.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

The 'Magnificent Seven' are not riding off into the sunset yet

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