Perspective on the Magnificent 7 and Valuations




This is Brad Barrie, Chief Investment Officer and Portfolio Manager with Dynamic Wealth Group.  Welcome to this market and economic update. In this video, we’ll discuss the market rally driven by the so-called Magnificent Seven and the impact on stock market valuations.

This is an important topic because the stock market continues to reach new all-time highs. Some investors may be nervous as they wait for the market to pull back. Others, on the other hand, might feel like they’re missing out, often times referred to as FOMO (Fear of Missing Out).

In the next few minutes, we’ll show that regardless of how you feel in this market environment, the time-tested principles of staying diversified and focusing on the long run are still the best ways to achieve long-term financial goals.  Or as I like to say, preparation over prediction.  

First, let’s define what the so-called Magnificent Seven even is exactly.  It is a group of seven fast-growing technology stocks, including some of the largest stocks in the S&P 500 (Meta / Facebook, Amazon, Apple, Alphabet / Google, Nvidia, Microsoft, & Tesla).  This chart shows the performance over the past few years.

You can see that these stocks have performed very well over the past year, contributing significantly to broader stock market indices like the Nasdaq.

However, it’s important to keep in mind that these stocks are also quite volatile, losing nearly half their value in 2022. Thus, it’s important to not focus too heavily on just the past year.  As the disclaimer goes that we have all seen many times says, “Past performance is no guarantee of future results.”

Second, the market rally has pushed valuation levels much higher. Valuations are very important for long-term investors since they tell you not just what prices you’re paying, but what you get for your money. After all, when you invest in a stock, you’re buying a piece of a company. The hope is that the value of that ownership in a company rises over time.

You can see from this chart that valuations levels have increased significantly over the past year. This includes not only the highly recognized P/E Ratio (price-to-earnings ratio), but also price-to-sales, dividend yield, and others.

It’s important to understand that valuations are not a market timing tool. Instead, they are guideposts that help us understand how to allocate funds in a portfolio. Higher valuations do not mean we should avoid stocks altogether, just that we should be more cautious and diversify across asset classes and sectors. If the economy does continue to grow and corporations increase their profitability, then valuations might improve over time.  Namely the E in the P/E Ratio could get even stronger, thus bringing down valuations.

You see over time; it is very hard to maintain these high levels of valuations.  So, on a very basic understanding one of two things could happen to these calculations.  Either the Price comes down or the earnings, sales, cash flow, etc. grow faster than the price.  Or technically a combination of the above could occur.

Beyond valuations, one concern that some investors may have, is that a small group of mega cap tech stocks is driving the whole market. While this has been the case to some extent over the past year, historically many stocks have contributed to broad market returns.

This chart, for instance, shows the difference between the standard market cap-weighted S&P 500 index and an equal weight index.

This distinction may sound technical but is actually easy to understand.  The standard market-cap weighted index weights a larger percentage of the index based on the market-cap or size of the company, thus more in placed larger stocks (like the magnificent 7).  So much so, that the top 10 holdings represent over 30%.  An equal weighted index does just that, it puts an equal amount into each stock.  So, for the S&P 500, it takes roughly 500 stocks and puts around 0.2% into each stock, so the top 10 holdings would represent around only 2% of the portfolio.

This chart shows that over longer time frames, an equal weight index has done quite well, even if in the most recent time frame it is underperformed. Thus, we should not overreact to today’s technology stock rally. It’s important to stay diversified, not just with asset classes, but with different approaches and techniques.  At Dynamic Wealth Group, we do not believe there is one answer to the best method of investing.  We instead believe in true diversification with not just asset classes, but with approaches (fundamental, quant & technical analysis should all be utilized).  In addition, incorporating alternative asset classes and approaches, can all lead to a more truly diversified portfolio.  

We believe the secret to investing is not in trying to predict the future.  I, nor anyone, knows for sure if the Magnificent 7 will continue to outperform.  Certainly, there can be signs one way or another, but no one knows what is around the corner.

We hope you found these insights valuable. If you would like to discuss any of these topics in more detail, please feel free to reach out. We look forward to speaking with you.









Disclaimer:

Clearnomics and Dynamic Wealth Group, LLC are not affiliated entities.  No part of this should be taken as investment advice.  Consult your financial advisor for specific investment recommendations tailored to your specific situation. 

Dynamic Wealth Group (“Dynamic”) is an SEC registered investment adviser. SEC registration does not constitute an endorsement of Dynamic by the SEC, nor does it indicate that Dynamic has attained a particular level of skill or ability. This material prepared by Dynamic is for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Opinions expressed by Dynamic are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable. Dynamic, however, cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source.

Dynamic does not provide tax or legal advice, and nothing contained in these materials should be taken as tax or legal advice.

Any reference to an index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indices

are unmanaged vehicles that serve as market indicators and do not account for the deduction of management fees and/or transaction costs generally associated with investable products. Past performance is no guarantee of future results. Actual returns may be lower.

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