Not the only game in town

Produced in association with our strategic partner J.P. Morgan Asset Management.

The US sharemarket has enjoyed a stunning run of late, led by a handful of companies labelled the ‘Magnificent Seven’. These seven companies are all technology giants and most have been associated with advancements in artificial intelligence. Investors are now questioning whether their incredible performances can continue and wondering about opportunities elsewhere in the market.

The Magnificent Seven comprises Microsoft, Apple, Alphabet (the owner of Google), Amazon, NVIDIA, Meta (previously known as Facebook) and Tesla.

The strength of their performances has pushed the S&P 500 index to a record high at a time when investors are growing concerned about elevated valuations, increasing market concentration and an economic slowdown.

Active management and broader diversification are important in this environment. We recommend investing in the best quality companies, which are not always the largest.

Market concentration in context

The dominance of a few companies has increased their weightings in the US sharemarket, and similarities are now being drawn to the technology bubble of the late 1990’s.

Taking a slightly broader view, the ten largest US companies now account for one-third of the S&P 500.

This is a larger share than the top ten companies represented during the technology bubble and marks the highest concentration since the 1970’s.

This may sound alarming but there are some differences between then and now, with earnings being the main one.

In the late 1990’s, technology companies were being valued based on esoteric metrics such as eyeballs viewing webpages, rather than earnings delivered.

Today, the ten largest companies account for a bigger share of the US sharemarket’s total earnings.

Can the stellar gains continue?

It’s difficult to deny that valuations of the Magnificent Seven companies appear elevated. Investors are paying a lot for short-term earnings growth and could be disappointed if their high expectations are not met.

Investors have a habit of overestimating the near-term implications of transformative technologies, but often underappreciate their long-term potential.

Although the Magnificent Seven companies are expensive, their valuations look less inflated when long-term earnings prospects are considered.

What about the S&P 493?

Earnings of the Magnificent Seven companies grew by over 30% in 2023, while the rest of the US sharemarket saw earnings contract by 4%.

This meant those seven companies accounted for all profit growth of the S&P 500 index last year. This could well change with the 493 companies outside of the Magnificent Seven expected to contribute to earnings growth in 2024.

Market performance started to broaden out late last year, as investor optimism about the prospect of a ‘soft landing’ for the US economy gained traction and bond yields fell.

A resilient US economy would see this trend continue, creating attractive opportunities to invest in other quality businesses that have less demanding valuations.

Take opportunities to diversify

Maintaining a disciplined approach to rebalancing is one of the simplest and most effective ways to manage portfolio risk and ensure that asset allocations remain aligned to long-term objectives.

Other parts of the US sharemarket now look more appealing, presenting opportunities to diversify.

Options also exist outside of the United States where the exposure to technology companies is smaller and valuations are not stretched.

After years of being unloved by investors and many economic false starts, the outlook for Japanese equities is also the best it has been in decades.

Higher inflation expectations are feeding through to wages, which should see improved domestic demand and consumption in Japan’s economy.

The Tokyo Stock Exchange is also driving improvements in corporate governance. These initiatives appear to be working and should help to unlock value for shareholders.

There are plenty of reasons to deploy cash this year and investors shouldn’t feel pressured to choose between the Magnificent Seven and companies elsewhere in the market.

Artificial intelligence should bring exciting changes to the world, but opportunities to invest in other areas are also compelling and could prove lucrative.

This is an excerpt of an article published in the latest edition of our flagship publication for clients only, News & Views. Craigs Investment Partners clients can view News & Views, including the full version of this article by logging in to the client portal.

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