- Combined market cap of the Magnificent Seven is back to where it was last September
- Their weighting within the S&P 500 index is gently moving lower
- Higher capex, lower cash flow and decreasing buybacks are all concerns
- The S&P 500’s weighting within the FTSE All-World is falling from its 2024 peak
- FTSE All-World ex-USA index is barrelling to new all-time highs
- MSCI Emerging Markets index looks to be breaking out on the upside, too
“Near-term market action is nearly always driven by two things: positioning and leverage. Or, in plain English, who is most overweight in which holdings and how much margin or borrowed money they have used to do the buying,” says AJ Bell investment director Russ Mould.
“It does not take much to create a panic in widely-owned stocks that have done well and where use of margin may be common, especially if their valuations stand at a big premium to wider markets. And this is where we may be right now when it comes to the AI hyperscalers, software-as-a-service (SaaS) providers, crypto and even silver and gold.
“In even cruder terms, it is like everyone deciding to crowd over to one side of a rowing boat because the view looks better there. At some stage, at least some of them are going to have to move back to the other side, or the boat will tip over and everyone will end up in the water.
“From an investment portfolio point of view that may be exactly what we are seeing now.
“Investors seem to be reducing exposure to areas of the market that have done incredibly well and may have become expensive as a result, and where expectations for profits and cash flow have shot up to levels where positive surprises may be hard to achieve and it is easier to disappoint than many may think.
“A case in point here seems to be the artificial intelligence (AI) hyperscalers and the Magnificent Seven, where ever-higher capital expenditure budgets are stoking concerns on four fronts:
Source: Company accounts, Marketscreener, analysts’ consensus forecasts. *Alphabet, Amazon, Meta Platforms, Microsoft and Oracle
- First, how the hyperscalers are moving from an asset-light business model to a more capital intensive one, and thus one potentially much more sensitive to minor changes in revenue, with the result that their earnings and cash flow are less visible or predictable than before.
- Second, how the hyperscalers are starting to actively compete with each other in earnest, in the field of AI.
- Third, whether the huge investments will generate the incremental revenue and additional revenue growth to justify the outlay and not dilute existing, very lofty returns on capital.
- Finally, growth in capex is massively outstripping growth in sales, with the result that the hyperscalers’ free cash flow is no longer quite so copious. The first signs of this are increased use of debt and a reduction in share buyback programmes. A drop in this largesse lessens near-term returns from shareholdings in these firms and also reduces price-insensitive buying in stocks which represent a very large chunk of the wider US indices.
Source: Company accounts for Alphabet, Amazon, Meta Platforms, Microsoft and Oracle
“Buybacks are still getting support across the Magnificent Seven from Apple and Nvidia. The latter seems to be the biggest beneficiary of the AI spending splurge, so sceptics may question when that tap could start to run less freely, while the former seems to be the one member of the septet that is taking a more guarded view of AI and keeping a tighter rein on capex as a result.
Source: Company accounts for Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla
“These concerns may help to explain why the aggregate stock market capitalisation of the Magnificent Seven is no higher than it was last September. This also means that, as a group, their market cap weighting within the S&P 500 has slipped to 35.7% from last November’s all-time high of 37.9%.
“In other words, the Magnificent Seven are underperforming, as investors look to recalibrate risk, rebalance their portfolios and look elsewhere for the best risk adjusted returns.
Source: LSEG Refinitiv data. Market cap data for Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla
“Given their still-considerable weighting within the S&P 500, this may be starting to take its toll on the headline US index, at least in relative terms.
“The S&P 500 index is still going up, but it is doing so more slowly than other benchmarks. The Mag7 may not be the only reason why, given uncertainties over presidential policies at home and abroad, especially with regards to tariffs, taxes and the Federal Reserve, let alone Greenland, while concerns over the galloping Federal debt and a weaker dollar may also have a role to play. Nor should it be forgotten that the US equity market trades in the top decile of its history on any valuation metric that investors care to use.
“Whatever the ultimate rationale, the S&P 500 has slipped to 60.8% of the FTSE All-World’s stock market capitalisation, down from its all-time high of 64.3% in December 2024.
“The US is underperforming, as the world questions the concept of American exceptionalism, or at least ponders what is an appropriate valuation to pay for access to it.
Source: LSEG Refinitiv data
“This subtle shift, or rebalancing, can also be seen in how the FTSE All-World ex-USA index is breaking to new all-time highs, after making very hard work of getting past the level that had called the top in each of 2008, 2018 and 2022.
Source: LSEG Refinitiv data
“Even more startling is the new-found momentum enjoyed by emerging markets. The MSCI Emerging Markets index is also breaking fresh ground after a move beyond the mark that capped its progress in 2008 and 2021. A decisive upward move from here could truly signal a shift in the market mood music, given how a weaker dollar, stronger commodities and a reflationary backdrop have, in the past, been good for EM equities.
“This is a stark contrast to the low-growth, low-inflation, low-interest-rate world that has prevailed for most of the time since the end of the Great Financial Crisis in 2009. That is to say an environment that favoured long-duration assets, such as government bonds, and equity sectors that offered the prospect of reliable, secular growth, such as technology.”
