Are We to Believe That the Magnificent Seven is Immune?

Today is not a pretty day for many investors.  After a brief hiccup of overnight relief from the avoidance of a government shutdown, US Treasury yields turned sharply higher, boosting the dollar and depressing global equities – with one notable exception.

First, the shutdown that wasn’t.  A reporter reached out to me on Saturday night, shortly after the news broke that the Senate had voted yes on the House bill to keep the government open (President Biden signed it shortly afterwards).  My knee-jerk response was fairly accurate this morning, when US investors awoke to modest gains in index futures:

“It should be a modest positive. It’s not as though markets seemed overly concerned about the prospect of a shutdown, so they won’t be euphoric about kicking the can down the road for 45 days. But it’s better than the alternative. It doesn’t really affect most stocks and bonds except psychologically.”

The positivity eroded quickly when bonds resumed their recent sell-off (remember, bond yields move inversely to bond prices).  Seeing 10-year rates climb by 10 basis points to levels not seen since 2007 –prior to the Global Financial Crisis – will do that.  European stocks, which were modestly lower, took a large leg down after the US opened.  Heading into their close, most Continental indices are off by more than -1%. 

Yet even as we approach the European close – a time of day when US-based traders often launch a flurry of buying simply based upon timing – we see the S&P 500 (SPX) up modestly and the NASDAQ 100 (NDX) up over 1%.  This is in spite of declining stocks outweighing advancers by about 3:1. Any guesses why?  The following picture should provide most of the explanation:

Heat Map for US Mid-Cap Stocks and Larger with Volumes Over 5 million Shares

Source: Yahoo Finance

Bottom line, when you have top-heavy, market-capitalization weighted indices, the general tenor of the market can be overwhelmed if there is sufficient enthusiasm or negativity toward the market’s behemoths.  That is what we see today.  The “Magnificent Seven” stocks are all higher – even despite the generally lackluster, if not downbeat, market mood.

To be fair, there is some stock-specific rationale for some of the advances.  Positive analyst comments on Nvidia (NVDA) and the group overall may have provided sufficient enthusiasm for an already well-loved cadre.  Perhaps this was sufficient to boost sentiment even in Tesla (TSLA), which opened lower on disappointing deliveries.  There is also a perception that new money comes into the markets on the first of the month.  Seemingly it is flowing into investors’ favorite names, despite the possibility that those names are being sold by investors who now need to raise funds to pay their now-resumed student loans. 

An article on MarketWatch, stating an analyst’s opinion that Magnificent Seven may be relatively cheap right now is probably the most beneficial to the group’s performance.  I can’t dispute his findings, which show that the group’s price/earnings (P/E) and PEG (P/E/growth) ratios have fallen faster than the rest of the market.  Those are factual.  But another fact is that while these valuations are cheap on a relative basis, they are hardly cheap on an absolute basis.  The article notes that those seven stocks have seen their average 12-month forward P/E’s fall faster than the other 493 stocks in recent months; however, the former group’s P/E fell to 27 from 34, more than the latter group’s fall to 16 from 18. 

Those statistics tell me that investors are still paying a significant premium for the growth they anticipate from these mega-cap tech companies.  It is indeed less of a premium, but a significant premium, nonetheless.

By the way, it’s fascinating how quickly the mood can change in the current market environment.  In the time it’s taken me to write this piece, we now have SPX about -0.5% lower and NDX up only +0.2%, though all of the sainted seven remain higher on the day.  Yields have continued to climb, with the 10-year now +13bp to 4.70%.  We may want to ask ourselves whether VIX, which is up 0.52 points to 18.04, is properly reflecting the potential for volatility over the coming days.