Earnings reports this week from five of the so-called Magnificent Seven stocks are putting a renewed focus on risks from the group’s outsize weighting in the S&P 500.
Last year, eye-popping gains for the huge tech and growth stocks accounted for the bulk of the S&P 500′s 24% rise, with the hefty market values of the seven making them a driving force in the market cap-weighted index. Their performance has already helped drive the S&P 500 up over 3% this year as of Tuesday’s close.
But concerns have grown that the companies’ huge influence can work both ways, dragging down the broader indexes if they falter.
Analysts at JPMorgan said on Tuesday the market’s narrow leadership was becoming “increasingly unhealthy,” with the Magnificent Seven - Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia and Tesla - accounting for nearly 29% of the S&P 500.
Should the Magnificent Seven stocks weaken, they are “going to have a serious impact on the indices because of the high weight they have,” said Matt Maley, chief market strategist at Miller Tabak. “Any meaningful pullback in tech is going to knock down the major averages and scare a lot of investors.”
The Nasdaq Composite Index is also market cap-weighted, while the 30-component Dow Jones Industrial Average is price-weighted. Of the Magnificent Seven, only Apple and Microsoft are part of the Dow Jones.
The current earnings season is poised to be a test of whether the megacap companies can live up to investors’ lofty expectations. The early returns were dour: All of the Magnificent Seven were trading lower on Wednesday morning, weighing on the S&P 500, following results from Microsoft and Alphabet late on Tuesday.
Microsoft, whose market value recently topped US$3 trillion, beat estimates for quarterly revenue, but shares were lower as investors absorbed news about rising costs to develop artificial intelligence features. Shares of Google parent Alphabet were down over 6% at midday Wednesday, as its holiday-season advertising sales disappointed and the company said spending on items such as servers to power AI would jump this year.
Wednesday’s share-price drops pared their respective year-to-date gains, with Microsoft last up 7% in 2024 and Alphabet up about 1.5%. Shares of Nvidia are up about 23% this year and Meta Platforms has gained 11%. Tesla shares, on the other hand, are down 23% so far in 2024, tumbling last week after CEO Elon Musk warned sales growth would slow this year.
In 2023, the Magnificent Seven individually soared between around 50% and 240%, and were collectively responsible for 62% of the S&P 500′s total return.
While that kind of performance has thrilled many investors, it has presented a more challenging environment for active fund managers, who seek to beat gauges such as the S&P 500 or Russell 1000 because many have held allocations to the Magnificent Seven that are smaller relative to the stocks’ weighting in those indexes.
Only 23% of large-cap funds that benchmark against the Russell 1000 beat the index last year, according to JPMorgan data.
Fund managers may hold less of the stocks for a variety of reasons, including a desire for portfolio flexibility, worries over owning too much of any one position and limitations imposed by the rules of their own funds.
“In an environment like this, diversified funds will struggle,” said Chuck Carlson, chief executive at Horizon Investment Services. “When you have just a few companies that are leading the way, managers can’t own those companies in enough bulk to offset that concentration of performance at the top.”
Indeed, the S&P 500 beat the equal-weight S&P 500, a proxy for the average stock in the index, by 12 percentage points last year. The equal weight index is trailing again so far in 2024, up just 0.4%.
In a note on Tuesday, BofA Global Research said the Magnificent Seven account for almost 20% of the market cap of the MSCI’s world equities index, with Apple and Microsoft each nearly the size of Japan, the second-largest country in the index.
The bank’s clients are worried about Magnificent Seven concentration and “that actives will only get more squeezed in to keep up with benchmarks/peers, further fueling upside momentum,” the firm’s analysts said.
The stocks could see more volatility later this week, when Apple, Amazon and Meta report quarterly results. To be sure, stellar reports could further invigorate the stocks and drive indexes higher.
“The fact that the market is very concentrated in them does worry me,” said Peter Tuz, president of Chase Investment Counsel, which owns the Magnificent Seven stocks except for Tesla. “Mitigating against that is for the most part these are exceptionally strong companies that dominate their niches.”
-- Lewis Krauskopf, Reuters
Also see: New U.S. ETF targets ‘Magnificent Seven’ mega-cap technology stocks
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The Rundown
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Clean energy stocks might be in for a much-needed recharge this year as bets on interest rate cuts brighten their outlook following record outflows from this former ESG hot spot. As Reuters reports, cost overruns, supply bottlenecks, and financing troubles have plagued debt-intensive wind and solar projects, but cheaper valuations are starting to lure investors looking to pick up bargains.
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Ask Globe Investor
Question: I have a stock in my non-registered account that I want to move into my tax-free savings account to make use of my TFSA contribution room. Do I need to report a capital gain as though I have sold it when I move it in?
Answer: With the annual TFSA limit having risen to $7,000 as of Jan. 1, not everyone has sufficient cash to max out their contribution. What’s more, about 90 per cent of Canadians have unused TFSA room from previous years, including many high-income earners who have failed to contribute the maximum each year, according the Canada Revenue Agency.
Transferring securities “in-kind” to your TFSA can be a great solution. But you need to be aware of the tax implications.
When you transfer shares with an unrealized capital gain from a non-registered account into a TFSA, the CRA treats the transaction as if you’d sold the shares. To determine the capital gain, subtract the adjusted cost base of the shares from their fair market value at the time of the in-kind transfer. The good news is that only 50 per cent of the capital gain is taxable.
If you have shares with an unrealized loss in a non-registered account, on the other hand, it’s generally a bad idea to transfer them in-kind to a registered account because the loss will be denied for tax purposes. It’s more advantageous to sell the losing securities first and then contribute the cash, which will allow you to claim the loss. Just remember to wait at least 30 days before repurchasing the securities in your TFSA (or any other account) to avoid running afoul of the CRA’s superficial loss rule.
One other thing to note: Capital losses must be applied against capital gains in the current year, but any remaining losses can be carried back up to three years or forward indefinitely to offset capital gains in other years.
--John Heinzl (E-mail your questions to jheinzl@globeandmail.com)
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