Q1 2024 Conversations on Markets

FIRST QUARTER, 2024

CONVERSATIONS ON MARKETS

Conversations on Markets is an extension of Bel Air’s Conversations Series, featuring discussions on topics ranging from investments to philanthropy, entrepreneurship, and conservation. 

The Magnificent 7 vs. S&P 493

At present, when you invest a dollar in the S&P 500, nearly 30 cents are allocated to only seven stocks, leaving the remaining 70 cents to be distributed among the other 493 stocks.  A group of very large companies, popularly referred to as the “Magnificent Seven,” include Apple, Alphabet, Microsoft, Amazon, Meta, Tesla, and Nvidia. They now represent a staggering 29% of the S&P 500’s market capitalization.

Source: BofA Global Investment Strategy, Bloomberg.

As of December 31, 2023.

This perspective becomes crucial in understanding the remarkable performance of the Magnificent Seven, which surged by 76% in 2023, overshadowing the mere 14% growth seen in the remaining 493 stocks.

Source: Goldman Sachs Global Investment Research.

As of December 31, 2023.

Source: Bloomberg, Strategas.

As of December 31, 2023.

Future earnings expectations across various sectors of the economy illustrate why the Magnificent Seven commands a higher valuation. Even though these seven companies represented a mere 17% of earnings of S&P 500 in 2023, they handily outpace the S&P 493’s 2024 earnings expectations. Given that they represent the concentration of growth opportunities and market share in many of the economy’s most important sectors – computing power, data storage, eCommerce, software, EVs, social media, smartphones, and media streaming – the magnificent Seven’s magnificent valuation might just be justified.

Yet, large cap companies’ valuations in the Technology and Communications sectors rely heavily on the current value of expected future earnings. Unsurprisingly, when interest rates moved meaningfully higher in 2022, the Magnificent Seven collectively experienced a 41% drawdown, while the S&P 493 only saw a 12% loss. In 2023, however, the situation has reversed as share prices rebounded, driven by optimism about the potential of artificial intelligence to boost future earnings. Consequently, investors have been willing to “pay up” for this promising future, as illustrated in the chart below.

Source: Goldman Sachs Global Investment Research.

As of December 31, 2023.

How should we interpret the performance divergence between the Magnificent Seven and S&P 493? One perspective suggests that America’s tech giants might be overpriced and are headed for an inevitable downturn. Another viewpoint suggests that just as stock prices have gone in different directions, the companies’ revenues and profits will also diverge, indicating that the Magnificent Seven are poised to outpace the older, more traditional companies in the S&P 493.

THE BEL AIR VIEW

Moderating inflation should allow central banks to cut interest rates. Restrictive monetary policy and post-pandemic supply chain normalization have curbed inflation, but higher interest rates could threaten demand going forward. Both equity and bond markets may face volatility depending on central banks’ monetary policy in 2024.

A historically strong labor market has supported the U.S. consumer, although cracks are appearing. U.S. consumers have been supported by a strong job market and savings accumulated during pandemic lockdowns. The Federal Reserve remains concerned about higher wages fueling higher inflation, but as prices normalize, higher wages should continue to support consumption.¹

High geopolitical tensions caused by conflicts and important upcoming elections could continue to impact supply chain dynamics. Along with the humanitarian strife, conflicts in the Middle East and Ukraine have created unpredictable movements in commodity markets. Increased geopolitical tensions and major elections in key geographies could continue to alter trade policy as the West looks to become less reliant on Chinese manufacturing.²

Increased fiscal spending has helped the U.S. economy and should continue in an election year. Fiscal spending with a large budget deficit has supported the U.S. economy, even as monetary policy tightened. The elections in 2024 should continue this trend as incumbents attempt to sway voters. Regardless of the outcome, political gridlock is likely to play out which tends to benefit markets.

M&A and IPO activity, as well as real estate transactions, should return to normal levels as inflation and interest rates go lower. M&A and IPO deal flow, as well as real estate transactions, slumped as markets adjusted to rising interest rates. As monetary policy eases, these markets could see activity increase.

RISKS TO OUR VIEW:

• Extended period of heightened inflation
• Fed overshooting
• Escalation in geopolitical tensions
• A deep U.S. recession
• Dollar strength

[1]

[2]

SOURCES:

(1) Bloomberg. Continuing jobless claims measures the number of people continuing to claim unemployment after initially filiing for unemployment. Data as of December 31, 2023.

(2) Strategas. Data as of December 31, 2023.