The S&P 500 is having a nice year in 2023 (+11.85% as of this writing) – certainly much better than pundits expected after a tough year in 2022. But no one seems especially excited about the stock market writ large this year. They are excited about a few particular stocks. The concentration of interest in a few names has birthed a new term: the Magnificent Seven: Apple, Microsoft, Amazon, Alphabet (Google), Meta (Facebook), Nvidia, and Tesla. Here’s year to date performance of the Magnificent Seven beside the S&P 500 (all seven of them are also some of the S&P 500’s largest constituents):[i]
11.85% for the S&P just doesn’t seem that exciting when Nvidia and Meta are both up over 150%...
Anyway, here are three things finance textbooks say about stock valuations and interest rates:
- The price of a stock is the present value of its future income stream. If interest rates are low, the present value of future income streams are high (if you can’t earn anything on your money now in the bank or in T-bills, might as well buy a stock that will pay you dividends eventually). The other side of the coin is higher interest rates negatively impact stock prices, ceteris paribus.
- Increasing interest rates are also bad for stock prices because they increase the cost of borrowing for companies, which squeezes margins, and decrease consumption for consumers, which squeezes revenues.
- The relationship between stock prices and interest rates above is especially magnified in growth stocks, i.e. stocks that don’t pay dividends. People buy these stocks because they’re excited about cash flows (dividends) far in the future. They don’t care about receiving cash flows today (they know these companies aren’t paying dividends anytime soon!).
Lately, “growth stocks” has been synonymous with “tech stocks.” Growth investors love tech stocks. Go change the world, capture the total addressable market, and then you can worry about paying me a dividend.
The Magnificent Seven stocks are all basically growth tech stocks. Yes, yes Amazon is technically a retail stock and Tesla is technically an auto stock. But come on, Amazon and Tesla are really tech stocks. And sure, Apple, Microsoft, and Nvidia pay a dividend, but no one buys them for the dividend today. People buy them for price growth. They are excited about cash flows in the distant future, not next year.
Back to what the textbooks say about interest rates and stock (especially growth stock) valuations. Here are interest rates from 2008 through 2021:[ii]
That looks like a giant increase in interest rates from 2016 to 2018 but notice the scale – the top was 2.5% in 2019 – still historically low. The basic reading of this chart is that interest rates were historically low from 2008 – 2021, the introduction of “Zero Interest Rate Policy” (ZIRP). Zero Interest Rate Policy was intended to be (or at least sold as) temporary. What is it they say about temporary government programs? Nothing so permanent…
Here are the Magnificent Seven stocks over the same period:[iii]
Don’t let Tesla and Nvidia’s wild run during that period mask the impressive outperformance of the other five components of the Magnificent Seven. All seven stocks crushed the S&P 500.
So the Magnificent Seven wildly outperformed during Zero Interest Rate Policy from ’08-’21. Kind of like the finance textbooks said they would. But they also outperformed during the (relatively) high interest rate regime of 2023 (Fed Funds rate currently 5.5%). Were the textbooks wrong? Have these seven companies discovered the secret to unstoppable price appreciation? Is indexing dead?
Everyone has already forgotten about 2022. The year the Fed finally relinquished its grip on ZIRP. The fastest rate hiking cycle in history.[iv] Here’s the Magnificent Seven and the S&P 500 in 2022:[v]
Yikes. Interest rates started rising in March ‘22 and growth tech stocks were slaughtered. No one remembers this because it happened longer than 24 hours ago, but last year the narratives went something like whelp the textbooks were right and have low interest rates been the reason for the runup in tech stocks since 2008? and are these tech stocks worth owning now that ZIRP is gone? I’m not kidding, this is what people were saying. No one wanted to be in tech/the Magnificent Seven in 2022. People wondered whether they were viable positions in a non-zero rate regime. Understandably! Remember the textbooks! The headlines were nasty:
Tech is Hitting the Brakes on Hiring Even as Other Industries Keep Adding Jobs – CNBC[vi]
Tech Companies Rocked by Layoffs as Industry Faces Biggest Downturn in Two Decades – CBS News[vii]
Top Tech Stocks Have Lost $3 Trillion in Market Cap in 2022 – S&P Global[viii]
Tech Stocks Crushed in Market Selloff - CNBC[ix]
Now, let’s examine the Magnificent Seven & the S&P 500 from the beginning of 2022 to the present:
Median Magnificent Seven stock: -7.58%
S&P 500: -6.67%
Funny how one more year of perspective alters the entire story…
So, a recap of the Magnificent Seven:
One word to describe Apple/Microsoft/Nvidia/Tesla/Meta/Amazon/Alphabet in 2023: Magnificent.
One word to describe Apple/Microsoft/Nvidia/Tesla/Meta/Amazon/Alphabet since 2022: Average*
How did one make a Magnificent Killing in the Magnificent Seven? You bought in mid to late 2022 when the Magnificent Seven companies were laying on the ground bleeding after waves of tech layoffs in the midst of a conversation about what the finance textbooks say regarding whether growth tech stocks could weather anything other than zero interest rates.
No one wants to buy the stocks that are laying on the ground bleeding.
Everyone wants to buy the stocks that are Magnificent.
But the way to outperform in individual stocks is to buy them long before anyone calls them Magnificent.
Or you could remove yourself from the entire stock-picking-and-timing-mess and let your wealth compound for decades in a diversified index portfolio.
Sean Cawley, CFP®
*Ok, ok Nivida has been magnificent since 2022. One of the seven. But notice all the magnificence happened during that gap up in May of 2023 after a blowout earnings report that cemented Nvidia as everyone’s favorite A.I. stock.[x] Until then it was basically tracking the S&P 500.
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Content here is for illustrative and educational purposes only. It is not legal, tax, or individualized financial advice; nor is it a recommendation to buy, sell, or hold any specific security, or engage in any specific trading strategy. Results will vary. Past performance is no indication of future results or success. Market conditions change continuously.
This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.
[i] YCharts, Fundamental Chart, Total Return Level, AAPL/MSFT/NVDA/META/GOOGL/AMZN/TSLA/^SPX, 01/01/2023 – 11/01/2023.
[ii] YCharts, Fundamental Chart, Target Federal Funds Rate Upper Limit, 10/29/2008 – 12/31/2021.
[iii] YCharts, Fundamental Chart, Total Return Level, AAPL/MSFT/NVDA/META/GOOGL/AMZN/TSLA/^SPX, 01/01/2023 – 11/01/2023.
[v] YCharts, Fundamental Chart, Total Return Level, AAPL/MSFT/NVDA/META/GOOGL/AMZN/TSLA/^SPX, 01/01/2022 – 12/31/2022.