Microsoft is adding AI to its products by partnering with OpenAI, a leader in generative AI. OpenAI chief executive officer Sam Altman, left, appears onstage with Microsoft CEO Satya Nadella, right, at OpenAI's first developer conference, on Nov. 6 in San Francisco.Barbara Ortutay/The Associated Press
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It has been a stunning year for the so-called “magnificent seven” stocks that have powered the U.S. stock market.
Shares of Alphabet Inc. GOOGL-Q, Amazon.com Inc. AMZN-Q, Apple Inc. AAPL-Q, Meta Platforms Inc. META-Q, Microsoft Corp. MSFT-Q, Nvidia Corp. NVDA-Q and Tesla Inc. TSLA-Q have gained 101 per cent so far this year, according to the Bloomberg Magnificent 7 Total Return Index. In contrast, the S&P 500 Total Return Index is up 21 per cent.
Although some technology-focused fund managers don’t expect these mega caps to rack up the monster returns of 2023, they are still making bullish bets – albeit to varying degrees – on most names.
“I think you will see some moderation [in gains] next year,” says Peter Hofstra, senior vice-president and co-head of equities at Toronto-based CI Global Asset Management. “We hold six of the seven names and believe they will be a source of positive returns next year.”
The U.S. technology sector took a severe beating in 2022 amid rising interest rates, higher inflation and slowing economic conditions, but the magnificent seven roared back to life this year.
“This group has been seen as a safe haven – that [these] companies can grow despite broader economic concerns,” says Mr. Hofstra, a portfolio manager on CI Global Alpha Innovators Corporate Class fund. “They have continued to do well as interest rates are likely not going higher.”
Of these companies, though, software giant Microsoft remains his top pick.
“If you’re only going own one name for a few years, I would say own Microsoft,” he says. “It has several growth engines on a strong subscription business.”
The company is well run with growth coming from its cloud services, Microsoft 365 software, and its gaming business after acquiring Activision Blizzard Inc., he says. It’s also adding artificial intelligence to its products by partnering with OpenAI, a leader in generative AI.
He also rates AI chip maker Nvidia, whose stock has surged 226 per cent this year, a top pick. Its earnings growth and top-line numbers are “staggering,” he says.
“Every corporation is going to have to learn to drive productivity gains, and a better client experience using AI,” he adds.
Mr. Hofstra also likes Amazon, which has used AI inferencing for years in its online retail business. The company benefits from robust cloud spending, while its e-commerce unit can cut costs related to fulfillment and delivery, he says.
“It has the ability to grow its earnings quite substantively,” he explains.
Alphabet, parent of Google, has tailwinds from digital advertising, growth in its cloud-computing business and its AI build-out, but there are also headwinds from anti-trust lawsuits, he notes.
He continues to own Apple, a maker of smartphones and other electronic devices. Mr. Hofstra calls the tech giant “a good, slow-growing stable franchise” that has been able to push through price increases on the services side.
Meta, which has high user engagement on Facebook and other platforms, is a holding, but “our concern is if its metaverse [a shared virtual reality] investment is going to a worthwhile spend,” he adds.
‘Elon Musk premium’ for Tesla
Mr. Hofstra doesn’t hold Tesla stock, partly due to the valuation for the electric vehicle (EV) maker. There are also growth concerns given price cuts on vehicles, competition from China, and automakers introducing more hybrids amid consumer worry about running out of a charge and getting stranded.
“You have to give the stock the Elon Musk premium – it’s Elon, so he’ll make it work, and disrupt the world,” he says, referring to Tesla’s chief executive officer. “I haven’t been prepared to do that.”
The magnificent seven stocks are “not cheap, so you’re paying for quality,” Mr. Hofstra says. “The growth is there to justify the valuation as a group, with Tesla being the outlier.”
Other tech stocks should see more gains next year, but it pays to be selective, he says. “It’s still a tough spending environment.”
He trimmed his weighting in Meta and Apple this year to invest in other names such as chipmaker On Semiconductor Corp. ON-Q and ad-buying software maker The Trade Desk Inc. TTD-Q.
Prices ‘baked in’
Robertson Velez, portfolio manager with Toronto-based CIBC Asset Management Inc., says he’s generally bullish on most magnificent seven stocks in 2024, but not to the same degree as earlier this year.
“The earnings will be fine, but a lot of that is baked in [the prices],” says Mr. Velez, who co-manages CIBC Global Technology Fund and Renaissance Global Science & Technology Fund.
These stocks gained attention because many are “quality technology names with significantly more cash [on their balance sheets] than most companies in the S&P 500,” he says. “They have very strong competitive advantages and are able to grow in a difficult environment.”
Microsoft, Nvidia, Apple, Alphabet and Meta are core holdings because they’re a large part of the technology and communication services portion of the MSCI World Index – the benchmark for Mr. Velez’s funds.
“The generative AI theme has more legs to go, and Nvidia and Microsoft are plays on that [theme],” he says.
Alphabet and Amazon are also AI plays, as well as Meta, although most of the latter’s gains stem mostly from its cost-cutting drive, he adds.
However, Mr. Velez has reduced his holding in Tesla significantly due to the company’s negative outlook on the EV space in the latest quarter.
“Higher interest rates are making it harder to sell EV cars,” he says.
Beyond the magnificent seven, he says there are other tech opportunities. He likes Broadcom Inc. AVGO-Q, a semiconductor firm which just acquired cloud-computing company VMware Inc.
And he favours names such as On Semiconductor; Palo Alto Networks Inc. PANW-Q, a cybersecurity play, and Synopsys Inc. SNPS-Q, a provider of software tools to help chip makers in the designing process.
‘Fundamental support for Tech’
Shane Obata, portfolio manager with Toronto-based Middlefield Capital Corp., says he wouldn’t be surprised if the magnificent seven returned about 20 per cent in 2024.
Mr. Obata, who oversees Middlefield Innovation Dividend Class fund and its exchange-traded fund version, Middlefield Innovation Dividend ETF MINN-T, says his top picks among these companies for next year are Microsoft, Nvidia and Amazon.
“Microsoft has likely emerged as probably the best company in the world now,” and its investment in OpenAI, which developed the ChatGBT chatbot, is showing tremendous momentum, he says.
Microsoft’s Office products are “pretty much mission-critical for businesses now,” and it will benefit from selling its AI-powered Copilot digital assistant on top of its Microsoft 365 software, he adds.
Nvidia is also compelling, he says.
“It’s the poster child of AI and really the only game in town for the best hardware,” he says. “If you’re an AI start-up and want to get moving as soon as possible, you will call on Nvidia.”
The story with Amazon is “profitability inflecting higher,” he says. It has had the lowest operating margin in the group, but its e-commerce business is becoming more profitable, while its higher-margin cloud-computing and ad businesses continue to grow, he adds.
Mr. Obata expects the returns among tech stocks to broaden beyond the magnificent seven next year. He has bullish bets on Palo Alto Networks, and Advanced Micro Devices Inc. AMD-Q, which recently launched new AI chips to compete against Nvidia.
“They have done well this year, but not as well as Nvidia,” he says. “There’s fundamental support for tech to do well again next year.”
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