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The wise second-in-command to Warren Buffett at Berkshire Hathaway, Charlie Munger — who died this week aged 99 — was a pioneer in blending investment and psychology. He warned about a “Lollapalooza effect”: the tendency for emotions and cognitive biases to reinforce each other and drive herd mentality. As stockpickers mull their strategies for 2024, many are wondering how much of this year’s buying frenzy over the so-called Magnificent Seven stocks — Apple, Alphabet, Microsoft, Amazon, Meta, Tesla, and Nvidia — is indeed mass hysteria, or actually grounded in reality.
Soaring interest rates were expected to subdue equity markets in 2023, but America’s S&P 500 has posted a 20 per cent total return so far. The rise, however, has been overwhelmingly driven by the seven tech giants. They account for 29 per cent of the stock index by market capitalisation — the highest for the seven largest listed corporations since at least 1980 — and have collectively returned a staggering 72 per cent. Hedge funds seeking to raise their long exposure to frontier technology, particularly generative artificial intelligence, have played a key role in pushing up their valuations. Exclude the Magnificent Seven and an “S&P 493” would have returned only 8 per cent, according to Goldman Sachs’s latest calculations.
The combination of heady valuations, concentration and high rates is troubling investors. Some fear rapid reversals akin to the dotcom crash in the early 2000s, or the slide of the “Nifty Fifty” in the 1970s — American blue-chips that had long been considered solid “buy and hold” growth stocks. In previous Fed rate-raising cycles, stocks have tended to rally after the final rate rise. The main exception was when the dotcom bubble burst. Market players are anxious about how it will play out this time.
Munger’s common-sense approach may offer some calm. First, humans have an urge to group things together. The Magnificent Seven are actually a mixture of businesses. While they are aligned to future trends, they span areas ranging from AI and semiconductors to the green transition. Their collective fortunes are not necessarily the same as their individual ones. Out of the seven, Berkshire Hathaway itself only has a major holding in Apple, which Buffett puts down to its brand and management.
Second, history is not the best guide to what will happen next. Markets actually rallied in November on bets that rate cuts will come sooner than expected. The Magnificent Seven also have to be put into context. Unlike the dotcom bubble, where high prices were often based on start-ups with overly ambitious business models, today’s tech companies are better established, boast sturdier balance sheets and have less rate exposure. Apple, Amazon and Microsoft, for instance, survived the 2000 crash, and came out stronger.
Third, the seven tech firms also have dominant global market positions — or “moats” in Silicon Valley parlance. Nvidia has about 95 per cent of the market for graphics processing units needed for training AI models. Alphabet’s Google has more than 80 per cent of the global search engine market.
Fears of a sharp reversal and a marketwide crash seem overblown. But while big tech stocks may be better at weathering weak economic activity in 2024, the Magnificent Seven are unlikely to match this year’s performance, which was also partly a reversal of a pullback in 2022.
Investors should, however, not be lulled into a false sense of comfort. In 2024, antitrust regulation, EV infrastructure rollouts and the adoption of generative AI will bring further clarity on the Magnificent Seven’s endurance. Each will be impacted in different ways. As Munger might say, in an industry of fads stay focused on the fundamentals.
