Will the ‘Magnificent 7’ continue to Drive Markets Higher?

Will the ‘Magnificent 7’ continue to Drive Markets Higher?

November 10, 2023

With earnings season winding down, having more than 450 of the 500 S&P constituents (or roughly 90%) reporting earnings by end of week, we take a look at the results thus far, while also highlighting the ‘Magnificent 7’ and how this basket of securities, making up nearly 30% of the S&P by market cap weighting, has driven earnings and performance this year.

As of November 3, 82% of companies in the S&P 500 reported earnings that surpassed expectations, well above the 10-year average of 74%. Results so far point to a 4.4% year-over-year gain, which would mark the first quarter of year-over-year earnings growth since Q3 2022. The consumer discretionary sector has produced the biggest average upside surprise (22%) among sectors, followed by communication services, financials, and tech with average upside surprises of 9-10%.

Earnings from the ‘Magnificent 7’—comprised of Apple/AAPL, Amazon/AMZN, Alphabet/GOOG/GOOGL, Meta/META, Microsoft/MSFT, Nvidia/NVDA, and Tesla/TSLA—were largely positive this quarter, with five of the stocks reporting results that exceeded expectations. TSLA was the lone constituent that reported a negative earnings surprise this quarter, as price cuts across its lineup of cars weighed on results. While NVDA has yet to report (November 21), investors are bullish on NVDA given their blowout earnings report last quarter and position within the budding artificial-intelligence (AI) industry.

Optimism surrounding the ‘Magnificent 7’ may be warranted, given their dominance in megatrends such as AI and cloud-computing. However, from a valuation perspective, these companies are trading at significant price-to-earnings (PE) multiples when compared to the rest of the world. The chart below shows the aggregate PE ratio of the ‘Magnificent 7’ compared to other asset classes.

View enlarged chart

You can see in the chart above that when compared to the S&P 500 equal weight index, the ‘Magnificent 7’ is trading at nearly twice the PE multiple. We consider this rich even when considering the double-digit earnings growth this group is generating at a time when earnings for the rest of the market are down slightly. When looking abroad, the PE appears nearly three times larger than the MSCI EAFE Index and the MSCI Emerging Markets (EM) Index, though these markets may be value traps because of weakening earnings outlooks.

We also looked at the free-cash-flow yields of the S&P 500 and split the constituents into quintiles. The free-cash-flow yield is a financial solvency ratio, comparing a company’s free cash flow per share to the market value per share. A high free-cash-flow yield means a company is generating cash that can be quickly used to service its debt and other obligations, or can be returned to shareholders as dividends or share buybacks. The chart below shows the free-cash-flow yields of the S&P 500.

View enlarged chart

You’ll notice the dispersion between the top quintile (blue) and bottom quintile (orange), when compared to the median (gray). While the ‘Magnificent 7’ appears to generate significant free cash flow, when considering the free-cash-flow yield, nearly all constituents of the ‘Magnificent 7’ fall into the bottom quintile, again highlighting the potential overvaluation of these stocks.

Given the growth characteristics of these companies in a year in which growth stocks have outpaced value stocks by a significant margin, it’s no surprise they have outperformed the broader market this year.

From an asset allocation perspective, the Strategic and Tactical Asset Allocation Committee (STAAC) remains neutral on style, with a positive bias towards growth stocks. Strong earnings thus far, coupled with attractive technical trends, position growth well in the near and medium-term. However, high valuations, tight financial conditions, and the potential for a recession (albeit mild) makes the STAAC wary to upgrade the position.



This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks  

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC. 

Tracking # 504072