In the past three months, the S&P 500 has climbed 13.8 per cent or 600 points. The Magnificent Seven group of stocks contributed 207 points or 35 per cent to the upside. This is despite the fact that Tesla Inc. shares have been sliding, removing 10.6 points from the index return.
The seven stocks – Microsoft Corp, Apple Inc., Amazon.com, Alphabet, Nvidia Corp., Meta Platforms, and Tesla – now account for 31 per cent of the S&P 500.
The U.S. benchmark is market cap-weighted, meaning that returns for the largest company, Microsoft Corp., affect index performance almost 800 times as much as stock price movements for the smallest company SolarEdge Technologies Inc. For this reason, the Magnificent Seven are likely to determine the direction of the S&P 500 and go a long way in determining returns for passive ETFs tracking it.
David Kostin, chief U.S. equity strategist at Goldman Sachs, is addressing concerns from institutional clients that the Magnificent Seven′s 30 times price to earnings ratio is too high to be sustainable when the rest of the index trades at a far more attractive 18 times earnings.
The strategist calculates that the seven stocks must post a compounded annual growth rate in sales of 12 per cent over three years to justify current valuations. A more achievable 3.0 per cent average is expected for the remaining 493 companies in the index.
Mr. Kostin notes that six of the Magnificent Seven stocks have reported fourth quarter results and, as long as Nvidia meets consensus analyst expectations for revenue when it releases results later this month, the group will have reported 14 per cent sales growth for the quarter. So far so good.
Goldman Sachs also noted that Magnificent Seven valuations are not as frothy as their megacap precursors were at the beginning of 2000. At that point, the five biggest companies were trading at 43 times earnings, a 73 per cent premium to the market average.
The strategist believes the Magnificent Seven are roughly fairly valued now based on short-and long-term growth prospects, profit margins and balance sheet strength. He adds, however, “the Tech Bubble shows that investors believe consensus estimates at their own risk. In March 2000, the consensus expected [the five largest companies] would grow sales at a 16 per cent [annually] over the coming two years. However, the group fell significantly short, realizing just 8 per cent growth.”
This group of five companies – Microsoft, Cisco Systems, General Electric, Intel Corp. and Exxon Mobil – would trail the S&P 500 by 21 percentage points in the next two years. In the current environment. investors with high exposure to the Magnificent Seven stocks, whether through individual stock holdings or ETFs, should expect volatility if sales results disappoint.
-- Scott Barlow, Globe and Mail market strategist
Also see:
Nvidia eyes fresh record as Goldman Sachs bullish on AI prospects
Tesla falls Monday after report of SAP snub, Piper Sandler price target cut
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The Rundown
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Low fees are your ally as an investor, but not 100 per cent of the time. The $19.9-billion RBC Canadian Dividend Fund is one of these exceptions. This actively managed mutual fund produced returns over the past decade that consistently tied or beat a heavyweight among index-tracking exchange-traded funds holding Canadian dividend stocks, reports Rob Carrick.
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Investors face some big choices when squirrelling away their cash in the stock market. They might put it into blue-chip dividend stocks to earn reasonable returns in exchange for a modicum of stability, or they might opt for riskier fare in the hopes of giant gains. Norman Rothery takes a look at three strategies using price-to-cash-flow ratios to find out how investors can maximize returns or pursue a less volatile approach. (Updates on all his portfolios for value and dividend investors can be found here)
Trying to predict a rate cut makes investors stupid. Focus on this instead
What has to be the most-anticipated interest rate cut in history has consumed financial markets of late, with speculation running wild over when the U.S. Federal Reserve will start to walk back policy rates from their 23-year high. Reporter Tim Shufelt asks: Do we really need to care this much? After all, we’re talking about a 0.25-percentage-point move, the mere timing of which is causing great swings in global stock prices.
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Trying to decide where to invest your RRSP contribution? Here are some ideas
As younger investors make Registered Retirement Savings Plan decisions, they should remember the basic goal of RRSP investing: Moderate growth at minimal risk. If possible, avoid losing money in your plan. If there is a setback, make sure it’s a small one. For this reason, Gordon Pape suggests dividing RRSP investment strategies into tranches, to be implemented at various stages as one ages. Here’s what he recommends.
ESG isn’t dead, it’s just evolving
Despite skepticism that’s spread through financial markets, ESG - the acronym encompassing environmental, social and governance principles - is not being eradicated. It is, however, maturing, says the Globe and Mail’s Jeffrey Jones. What we may see is a rebranding – getting rid of the acronym and slicing up its parts – as it becomes less of a separate class of investible assets and more of a series of accepted risk-management tools alongside those used in financial accounting.
Others (for subscribers)
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Ask Globe Investor
Question: The BMO Covered Call Canadian Banks ETF (ZWB-T) has an annual dividend yield of 7.5 per cent, based on the most recent monthly distribution. How can this be when the Big Six banks yield, on average, a little more than 5 per cent?
Answer: The answer is in the ETF’s name – specifically the words “covered call.” To generate additional income, the fund sells call options on a portion of its underlying bank shares. A call option gives the buyer the right to purchase a stock at a specified “strike” price before a certain date. (They’re referred to as “covered” calls because the ETF owns the stocks on which the options contracts are written, as opposed to “uncovered” or “naked” calls, in which the option seller does not own the stocks.)
Selling options generates additional income for the fund, which allows it to pay a fatter yield. The downside is that, in a rising market, the fund will have more of its stocks “called away” if the market price rises above the strike price. This is why covered call ETFs tend to do best in flat or falling markets and underperform when stock prices are rising. Keep that in mind, especially now that interest rates appear to have peaked and many beaten-down dividend stocks, including banks, have posted double-digit gains in the past few months.
--John Heinzl (E-mail your questions to jheinzl@globeandmail.com)
What’s up in the days ahead
Regulators are sharpening their anti-competitive oversight and actions in both the U.S. and Canada. Philip MacKellar of the Contra Guys will explain how this may impact your portfolio.
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Globe Investor Staff