The Magnificent 7
The current level of concentration of tech giants in US markets is unprecedented. Could this be a bubble in the making?
The Magnificent Seven is the new acronym everyone is talking about in global equity markets. They are the seven largest companies by market capitalisation in the US (Microsoft, apple, Nvidia, Amazon, alphabet, meta, Tesla) and have been on a tear over the past few years. These companies have seemingly been the driving force behind the markets, and their earnings, most recently Nvidia’s, drive market sentiment. Rarely have so few stocks been so important for global equities.
If we look at relative performance, the reason for the hype is obvious. Over the last nine years, the Mag Seven stocks have surged more than 18 times, compared to less than three times for the S&P 500. As these seven stocks have gained greater prominence, the US stock market has become increasingly concentrated. Today, the top decile of stocks in the US account for more than 75 per cent of total market capitalisation. The only other time we have seen this level of concentration was at the bubble peaks of 2000 and 1929. Worryingly, in both the prior periods, this ratio eventually meanreverted to 60 per cent. Since 1926, the median ratio of concentration for the US has been 63 per cent.
If we look at the top five stocks, at 25 per cent of the S&P 500, this ratio is back to the peak of the Nifty 50 era of the late 1960s. Even the top 10 stocks, constituting 34 per cent of the S&P 500, have never been a bigger part of the market than today. Driven by the Mag Seven, concentration, whichever way you cut it, has never been higher.
When we look at the absolute values of these stocks, one starts to realise why this concentration has occurred. Taken together, the Mag Seven stocks, with a market capitalisation of $13 trillion, would be on their own the second-largest stock market in the world, larger than China and more than double the third-largest market, Japan. The single largest stock, Microsoft, at a market capitalisation of over $3 trillion, would on its own be the fifth-largest market in the world (just after India). Today, Microsoft and Apple individually have market capitalisation greater than the UK stock market. The scale and absolute size of this magnitude are unprecedented in my experience.
Even on the basis of profits, we are in a different world. Taking trailing 12 months profits, the Mag Seven have a total net profit of $361 billion—almost equal to the total profits of corporate Japan and half the profits of all the companies listed in China.
Their profits on an absolute basis are more than double the profits of all the companies listed in India ($151 billion: Source DB). Apple alone over the last 12 months, delivered a net profit of $101 billion, 70 per cent of the profitability of all listed Indian corporations (source: DB). Combined, Apple and Microsoft deliver 20 per cent more profit than all the listed companies in India. I don’t think we have ever seen a phenomenon of companies with market capitalisation and profitability equal to large countries before.
However, does this scale and concentration on its own imply that we are in a bubble? First of all, while the current concentration is as high as the US has ever seen, it is not an outlier from a global perspective. All other global markets are far more concentrated. Most have a ratio of top 10 stocks over 50 per cent, and many have single stocks at over 25 per cent, compared to 8 per cent for the US. The size and profitability of these platform companies is also due to their network effects, global penetration and the inability of regulators until recently to rein them in. How do you compete against a company spending more than $30 billion a year each in terms of capex and research and design (R&D), as all the global platform stocks do? And how does one compete against Nvidia, which has the software/hardware integration, head start in graphics processing units (GPUS), and has locked much of TSMC’S leading edge Fab capacity?
These competitive advantages get only further enhanced in the world of artificial intelligence (AI). The cost of compute for training and inference and the need for data ensure that only two or three global companies will dominate the development of large language models.
Either regulatory action or an innovator’s inability to adapt business models to AI may be the only way these stocks lose their clout. However, while it is tempting to look at the size of these seven companies, their concentration, relative performance and the valuation of the US, jumping to the conclusion that we are in a bubble may be too hasty a judgement.
If we look at other indicators on sentiment, initial public offering, new investor numbers and margin debt levels, we are in a bull market, but not a bubble. Similarly, retail trading activity and flows into equities are not at bubble levels either. There remains a wall of worry around the US markets, and, in my opinion, we have not yet reached euphoria. Longterm bull markets typically end with euphoria. It may come, as we are about to enter an interest rate easing cycle, with markets at all-time highs!
The hype around AI continues to build and will overshoot. Falling rates and easing liquidity can supercharge the AI hype further. AI provides the unquantifiable technological disruption narrative, which when combined with liquidity/leverage and sentiment, can drive markets into a bubble.
What is clear is that long-term returns from here for the US are likely to be muted. Valuations are not useful for short-term market timing as markets can overshoot and stay expensive for years. However, valuations remain the best possible predictor of long-term returns.
In the US, initial starting point valuations explain more than 80 per cent of the subsequent 10-year returns. Based on research done by Bofa, at current valuation levels, one should not expect more than low-single digit returns from US equities over the coming decade. This comes at a time when the fiscal outlook and debt dynamics in the US has never been worse and the dollar looks set to enter a long-term cycle of depreciation. The US has had an incredible 15 years of both absolute and relative performance, and currently represents 62 per cent of global market capitalisation. It was higher than this in the mid-1960s, when there was no China and emerging markets. This relative performance dominance will reverse at some stage. The US cannot outperform forever.
While markets in the US may continue to rise in the short term, the conditions for an eventual blow-off are visible. Irrespective of this, the longterm outlook for US equities is mediocre. This interplay between the short-term and long-term outlook for US equities is a delicate balance all allocators will have to strike. To the extent allocators recognise the long-term dynamic and move money overseas, India will benefit.