Is it now time to sell the Magnificent Seven?

America’s leading tech stocks more than doubled last year – but high interest rates make investors wary

Only a few weeks ago, a key question for investors was: “have I still got time to buy into the Magnificent Seven?” Fear of passing up the stellar returns delivered by America’s leading tech stocks was palpable. Now we’re all asking: “Is it time to sell?”. Not fear of missing out, just plain old fear.

It’s not hard to see why the “Fomo” should have kicked in. In the five years to the recent peak in March, even the worst performer of the seven, Amazon, had nearly doubled an investor’s money. The best, Nvidia, had increased a well-timed investment 20-fold. Apple, Alphabet, Microsoft and Meta had trebled an investment made just before the pandemic. Tesla had turned £100 into £1,000 over the same period.

Last year, these seven stocks more than doubled, while the remaining 493 companies in the S&P 500 gained just 12.5pc. The top seven companies delivered about 60pc of the index’s 26pc return for the year. And the fever continued through the first quarter of this year, as Nvidia added another 90pc to the 240pc it had chalked up in 2023. No wonder US tech funds took in $5bn (£4.2bn) in the first two months of this year. It’s just as easy to see why investors have now started to question their enthusiasm. Over the past month, only Alphabet has made any progress.

The other six have all lost money for investors. Tesla and Nvidia have both shed more than 15pc of their value in a few weeks. Tech stocks marched the US market up to the top of the hill. Now they are leading it down again. When markets get frothy, I look out for the “tell” – the sign that something is wrong. During the dotcom bubble, my light-bulb moment was when a so-called incubator fund – a pile of cash waiting to be invested in internet stocks – traded at a multiple of the money investors had put up. When it costs you £5 to buy a pound, you don’t have to be Warren Buffett to spot the red flag.

The tell this time was when I heard that a highly regarded US fund manager had tweaked the position limits within his fund to allow him to buy more of the best-performing stocks. Active managers have struggled to keep up with the US market in recent years because they have not been able to hold enough of the handful of big shares required to match the market. That’s hard to accept when you are judged by your relative performance, but it is a poor reason to change the rules.

A second sign of potentially excessive exuberance is the coining of the magnificent moniker itself. We’ve been here before. Back in the early 1970s, a set of one-decision, buy-and-hold stocks was labelled the Nifty Fifty. These were high quality companies – the likes of Coca-cola and Xerox – which were growing their profits fast, supported by strong balance sheets and great brands. It was a difficult time for the US economy and investors craved the security these companies seemed to offer. Which all sounds very familiar.

The Nifty Fifty craze did not end well. But the parallels are not exact. We need to look at two things – how fast and sustainably the companies are growing, and how much investors are paying for a slice of the action. The two are related.

It does not take too many years of above-average growth to justify even an apparently high valuation. Sometimes it is worth paying up. This theory was tested to destruction by the Nifty Fifty. In 1972, the average stock in this group traded on a multiple of nearly 50 times the previous year’s earnings. That valuation was 2.5 times higher than that of the rest of the market. And it made the Nifty Fifty vulnerable when things turned down. The shares fell more than the rest of the S&P 500 in the 1974 crash and then recovered more slowly.

This week, four of the Magnificent Seven will lift the lid on their latest quarterly profits. Ignoring Tesla (which arguably shouldn’t be in this Ai-focused group), the numbers from Meta, Microsoft and Alphabet are expected to be strong, perhaps 40pc ahead of last year on average. I suspect they will be good enough to justify a valuation premium, which is still modest by comparison with that enjoyed by the Nifty Fifty. The Magnificent Seven’s performance is only partly about rising valuations. It has been justified by superior earnings growth too.

So I don’t think the fundamentals are enough to derail the Super Six, or whatever we end up calling them. What might, however, is the other big story in investment at the moment – the realisation by investors that interest rates are likely to stay higher for longer, in the US at least. The abandonment of the belief that interest rates would fall quickly from this summer is bad news for high-growth companies.

Much of their value derives from the profits they will earn in future years. These as-yet-unearned profits are worth less to an investor today if inflation and interest rates remain high. I might pay 80p for the promise of a pound in 10 years’ time if I expect inflation of 2pc a year but only 60p if prices are forecast to rise at 5pc a year. In both cases my real purchasing power will be the same a decade from now.

That’s the main reason why the Magnificent Seven have paused for breath. The growth is still there; these are great companies, with the benefit of size and first mover advantage. It’s just that the future is more uncertain than we thought. And, rightly, that reduces how much we will pay to jump aboard.

‘When it costs you £5 to buy a pound, you don’t need to be Warren Buffett to spot the red flag’