Can the Magnificent Seven sustain their trajectory? Mixed views from Six Leading Research Notes
History is a vast early warning system. – Norman Cousins
If history is any indication, there’s a really good chance we’ll experience some reversion to the mean, that may impact some, if not all of the Magnificent 7 stocks, whose valuations (and volatility) have soared in the recent past, not to mention broader markets, as well.
Mark Cuban is renowned for being one of the few dot-com entrepreneurs who successfully navigated the tumultuous period of the dot-com bubble, preserving his fortune in the process. In 1999, Cuban sold his internet-radio startup, Broadcast.com, to Yahoo for $5.7 billion in Yahoo stock. Recognizing the volatility and potential for a market downturn, Cuban was prudent, and took strategic steps to protect his newfound wealth.
Cuban worried about the possibility of a crash, during his lock-up period, on account of his past experiences in the tech industry, where he had seen companies rise and fall rapidly. To protect his fortune, Cuban worked with Goldman Sachs to implement a financial strategy known as a "collar" trade.
According to Javier Altimari at Oppenheimer1
Back in 1998, Mark Cuban and his partner Todd Wagner sold Broadcast.com, a giant multimedia company focused on streaming audio and video, to Yahoo! for $5.7 billion. At the time, Mark Cuban received 14.6 million shares of Yahoo trading at $95, thus his concentrated position had a market value of $1.4 billion. In order to protect the value of the 14.6 million stocks he decided to set up a costless Options Collar, which allowed him to protect his billions without paying any insurance premium. Probably because there was a lock-in period for him to sell the Yahoo share, or he used these Yahoo shares as collateral for a bank loan, or he didn't want to miss the opportunity if Yahoo continued to rally, he chose to enter a collar to lock in his share value without selling the shares. Here is the detail of the option trade:
1) For each 100 shares of Yahoo stock, 1 contract of put (strike 85) was bought and 1 contract of call (strike 205) was sold. In total there were 146,000 contracts of calls and 146,000 contracts of puts traded.
2) The premium of the put exactly offset the premium of the call, thus there was zero cost for this trade (Mark probably had to pay a commission but it is likely the commission cost was rolled into the premium as part of the total deal between Mark and brokers or counterparts).
3) All options expired in 3 years.
Such option structure is called a Collar and it consists of two legs: buying a downside put and selling an upside call. A costless collar has the premium of the put offsetting the call's exactly so that there is no cost to enter the collar trade.
The Magnificent Seven stocks—made up of the leading tech giants—have gotten a disproportionate amount of attention, and enormous valuation, in recent years, dominating discussions on market performance and investment strategies. Six notable research notes from Bank of America (BofA), Cornell Capital, GMO, KKR, J. Safra Sarasin, and Fred Hickey’s The High-Tech Strategist provide a variety of perspectives on whether these (no exaggeration) incredible stocks can sustain their stratospheric valuation trajectories.
While each of these research pieces acknowledges the prominence of the Magnificent Seven, their views diverge on the sustainability of their dominance, the associated risks, and the broader implications for the market. There is no question whatsoever that every one of these seven companies are blockbusters, life-transforming companies; The question is whether their shares can continue to be the blockbuster performers that have brought us to this moment.
In this piece we explore the similarities and differences in these views, and draw on direct quotes from the reports to present a balanced analysis.
BofA: Anticipating a Shift in Market Dynamics
BofA’s perspective2 on the Magnificent Seven stocks is rooted in the expectation of a shift in market dynamics. The firm recognizes the current dominance of these stocks but predicts a deceleration in their performance.
BofA notes, "Broadening out: Magnificent 7 expected to decelerate, while the rest is expected to improve."
This view suggests that while the Magnificent Seven have driven recent market gains, other sectors are poised to catch up, potentially leading to a more balanced market performance in the near future.
BofA's analysis is data-driven, focusing on market breadth and technical indicators.
The report highlights that "globally, 66% of stocks, 92% of industry groups and 83% of markets are trading above their 200-day moving averages."
This indicates a strong overall market performance, which BofA interprets as a sign that the broader market, beyond the Magnificent Seven, is healthy and may soon share more evenly in driving market returns.
Cornell Capital: Caution Amidst Dominance
Cornell Capital3 shares BofA’s concern about the sustainability of the Magnificent Seven’s dominance but takes a more cautious tone. The firm emphasizes the potential risks associated with the market's heavy reliance on these few stocks.
Cornell Capital observes, "The dominance of the Mag 7 has led to a significant divergence between the return on the S&P 500 Index, which is value-weighted, and an equal-weighted index of the same 500 stocks."
This divergence highlights the outsized influence of these stocks on the market, which Cornell Capital views as a potential vulnerability.
The firm's report expresses skepticism about the long-term viability of this concentration, stating, "We view the continued rise in the market based largely on the performance of a handful of huge technology stocks as an unsustainable situation."
Cornell Capital’s analysis suggests that the market's over-reliance on these stocks could lead to a correction, particularly if the broader market fails to catch up or if these stocks experience a downturn.
GMO: Drawing Parallels with the 2000 Tech Bubble
GMO provides a nuanced view4 that draws parallels between the current market and the 2000 tech bubble.
The firm acknowledges the similarities in market concentration and volatility, noting, "The narrowness of the market, the elevated cross-sectional volatility, and the concentration of capitalization in a few issues all look similar to the 2000 top."
However, GMO also distinguishes the present situation by emphasizing the improved fundamentals of today's top companies compared to those in 2000.
GMO’s report argues that while the market’s technical characteristics resemble those of the 2000 bubble, the fundamentals of the Magnificent Seven are stronger now.
The firm notes, "Unlike in 2000 when we held only a non-material weight in the top 10, we invest with confidence in a number of these companies today."
This confidence stems from the belief that today's leading tech companies have more robust business models, better capital allocation, and stronger barriers to entry, particularly in areas like AI and digitalization.
KKR: Optimism in Tech Sector Growth
In contrast to the caution expressed by BofA, Cornell Capital, and GMO, KKR adopts a more optimistic5 stance on the growth potential of the Magnificent Seven. The firm highlights the significant role these companies play in driving innovation and investment within the tech sector.
KKR points out, "Keep in mind that the Magnificent 7 accounts for over 20% of U.S. tech capex and R&D, and they are growing spending at a 15-20% annual rate."
KKR’s analysis suggests that the continued investment in AI, data centers, and other tech infrastructure by these companies could sustain their dominance and drive further growth.
The firm’s bullish outlook is grounded in the belief that the Magnificent Seven are not only maintaining their market position but are also crucial drivers of technological advancement and economic growth. This view contrasts with the more cautious perspectives of the other firms, which focus on the risks associated with such concentration.
J. Safra Sarasin: High Expectations and Potential Challenges
J. Safra Sarasin (JSS) provides a balanced view6, acknowledging the high expectations placed on the Magnificent Seven while also recognizing the potential challenges these companies may face in meeting those expectations.
JSS states, "Expectations are quite elevated for tech, so we think it will be challenging for them to outperform in the near term."
This cautious outlook reflects a concern that the market may have already priced in much of the anticipated growth for these companies, leaving little room for upside surprises.
JSS' analysis suggests that while the Magnificent Seven have driven significant gains, the pressure to continue delivering strong performance is mounting, which could lead to increased volatility if these companies fail to meet market expectations.
Comparing and Contrasting the Views
The five research notes share some common concerns regarding the concentration of market power within the Magnificent Seven stocks, but they diverge significantly in their interpretations of what this means for the future.
Caution on Sustainability: Both Cornell Capital and BofA express concerns about the sustainability of the Magnificent Seven’s dominance.
Cornell Capital warns that the market’s reliance on these stocks is "an unsustainable situation," while BofA anticipates a deceleration in their performance as other sectors improve.
Optimism vs. Skepticism: KKR stands out with its optimistic view, emphasizing the ongoing investment and innovation driven by the Magnificent Seven. In contrast, GMO, while recognizing the improved fundamentals of these companies compared to the 2000 tech bubble, still advises caution based on historical parallels.
Balancing Expectations: J. Safra Sarasin and GMO both acknowledge the high expectations placed on these companies. However, J. Safra Sarasin is more focused on the challenges of meeting these expectations in the short term, whereas GMO takes a longer-term view, emphasizing the quality and resilience of today’s top companies.
Conclusion: A Balanced Perspective
The divergent views expressed in these research notes underscore the complexity of the current market landscape. While the Magnificent Seven stocks have undoubtedly played a significant role in driving recent market gains, the sustainability of their dominance remains a point of contention among analysts.
BofA and Cornell Capital caution against over-reliance on these stocks, warning of potential risks and the need for broader market participation.
GMO offers a more nuanced perspective, recognizing both the similarities to the 2000 bubble and the differences in today’s market fundamentals.
KKR’s optimism highlights the potential for continued growth driven by tech sector investments, while J. Safra Sarasin tempers expectations by acknowledging the challenges these companies may face in maintaining their momentum.
In navigating the market, investors would do well to consider these varied perspectives, balancing the potential for continued growth against the risks of concentration and the challenges of sustaining high expectations.
The Magnificent Seven may remain central to the market’s narrative, but the broader context and potential shifts in dynamics will be crucial in determining their future trajectory.
Finally, Warren Buffett sent the market a telegram this year
Finally, to cap off this discussion, Fred Hickey, publisher of ‘The High-Tech Strategist,’ comments7 on Warren Buffett's sale of $75.5 billion worth of Apple stock. Hickey notes that Buffett’s decision to sell almost half of Berkshire Hathaway’s Apple position, after already reducing it by nearly 13% in the first quarter, is a significant move.
Hickey had previously predicted that Buffett would continue to reduce his Apple holdings due to the stock's enormous valuation. He states:
"It was the second consecutive quarter of Apple share sales by Buffett. I doubt it will be the last given Apple’s still-enormous valuation. Buffett doesn’t like the current stock market valuations, which is why he’s building up a massive cash position."
“There remain only a handful of companies in this country capable of truly moving the needle at Berkshire, and they have been endlessly picked over by us and by others,” Buffett, 93, stated in his annual shareholder letter, which Berkshire Hathaway released in February. “Outside the US, there are essentially no candidates that are meaningful options for capital deployment at Berkshire. All in all, we have no possibility of eye-popping performance.”
Can it really be that straightforward? The world’s greatest investor, and once single largest shareholder has been cashing out of one of his more recent darlings? Was it for tax reasons, since his cost base is $34, and capital gains taxes are expected to increase dramatically, or concerns about the economy, rates, or return outlook?
Whatever his reasons, can we really risk ignoring Buffett’s magnificent ‘telegram’? Be prudent. After last week’s rapid-fire rout and nearly as rapid recovery, it looks like we just got a second chance to rotate, rebalance asset allocation, rebalance for risk budget, or perhaps consider taking out some portfolio insurance in the form of options.
Thank you for reading this inaugural post of Insight & Opinion. Stay tuned for more.
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Footnotes:
"Mark Cuban's Genius Trade: Protecting $1.4 Billion | LinkedIn." 14 Aug. 2024, https://www.linkedin.com/pulse/mark-cubans-famous-trade-concentrated-stock-a-altimari-cfp-.
The High-Tech Strategist, Fred Hickey, August 4, 2024