Investor infatuation with seven high-profile U.S. technology stocks this year has made major benchmarks appear awfully lopsided. While the share prices of tech giants are surging, much of the rest of the market is just sitting there.
Some investors believe that this unusual tilt, the most extreme in decades, is creating opportunities.
“Our analysis suggests that investors’ myopic focus on the Magnificent Seven” – the popular term used to describe Apple Inc. AAPL-Q, Microsoft Corp. MSFT-T, Alphabet Inc. GOOG-Q, Amazon.com Inc. AMZN-Q, Meta Platforms Inc. META-Q, Nvidia Corp. NVDA-Q and Tesla Inc. TSLA-Q – “may be causing them to ignore other large cap growth stocks,” analysts at Richard Bernstein Advisors (RBA) said in a note this week.
The New York-based investment firm, founded by Richard Bernstein – a Wall Street strategist who famously turned bearish on tech stocks in the late 1990s, prior to the bubble popping – ran a screen that looked for growth stocks within the MSCI USA Index. The key parameter: Companies with forecasted next-year earnings growth of at least 25 per cent.
The screen found 82 stocks that qualified, and only three of them are the seven big tech stocks that are dominating the market this year.
“It’s pretty clear there is nothing particularly unique about the Magnificent Seven’s fundamentals. Rather, price momentum and excitement around the story alone seems to be luring investors to the stocks,” the analysts said.
The strategy of avoiding this year’s winners is a popular topic among investors who disdain stocks that appear to be priced for perfection, or who believe that artificial intelligence won’t live up to the hype.
An exchange-traded fund that tracks the performance of the Standard & Poor’s 500 Index is exposed to the seven AI-focused stocks. Some strategists have recommended an equal-weighted version of the index, which has lower exposure to them and may be poised for better returns.
This approach hasn’t worked – yet. The equal-weighted S&P 500 is up just 4.4 per cent this year, compared with a gain of just 19.4 per cent for the traditional version of the index. The equal-weighted version has trailed over the past one month and three months as well, suggesting that the tech trend hasn’t faltered.
Another approach is to focus on value stocks, which are cheap relative to their earnings. This approach has also failed to produce results: The Russell 1000 Value Index has underperformed the Russell 1000 Growth Index by a demoralizing 34 percentage points this year, and trails over the past month and three months.
Give some credit to the Magnificent Seven stocks. In 2023, they are up an average of nearly 106 per cent. The gains reflect the widespread view that these companies will see the most immediate impact from the commercial rollout of generative AI.
The impressive rally is unusual, though, because it is out of whack with the rest of the market. On average, 49 per cent of stocks outperform the S&P 500 annually for data going back to 1990, according to RBA. This year, only about 25 per cent of stocks are outperforming, which is the lowest annual reading in at least 33 years.
This is what’s known as narrow leadership, and it typically suggests that overall corporate profits are deteriorating, pushing investors into rare stocks that are poised to beat the downward trend.
But as RBA’s stock screen showed, this isn’t the case today: Plenty of other stocks, despite meagre gains year-to-date of just 7 per cent on average, show strong profit growth that can exceed the likes of Nvidia, Microsoft and Alphabet.
RBA didn’t reveal any of the individual stocks that made its screen and declined a request for examples, citing its focus on macro-driven strategies.
However, its report showed that investors don’t need to confine themselves to tech stocks when seeking growth. The screen had an overweight exposure to telecom, consumer discretionary and energy sectors, relative to the index – surpassing the weighting given to the tech sector. Remarkably, even the real estate sector, which has struggled with rising interest rates, had the same weighting as tech.
The takeaway: A handful of big tech stocks have delivered outsized gains in 2023, but some savvy investors are looking for opportunities among far less popular stocks that promise equal or better profit growth. They might not be plays on AI, but perhaps there are other ways to make money.