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Mega-cap “Magnificent Seven” accounted for 73% of first-half S&P 500 gains.
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There are five key questions for investors watching the highly concentrated rally in equities this year.
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Investors should avoid expensive, cluttered tech names and look for healthy balance sheets.
The handful of tech companies that have dominated the stock market landscape should continue to gain, but the resulting bubble requires closer examination.
That’s according to Bank of America, which says these “Magnificent 7” names – made up of Nvidia, Meta, Alphabet, Microsoft, Tesla, Amazon and Apple – account for 73% of S&P 500 gains in the first half of 2023, and together account for $11 trillion in market capitalization.
For investors watching and wondering if now is the right time to jump in, the bank says there are five key questions that need to be answered.
1. How did it happen?
While recent commentary points to artificial intelligence as the catalyst for the current surge in tech stocks, BofA is also considering a few other factors.
According to the bank, the era of near-zero interest rates of the previous decade helped impose a “no money today, big growth tomorrow” economic mentality, while market dynamics put the focus on large companies.
This period was also accompanied by an international arms race in the technology sector, characterized by increased spending, fiscal support and a looser regulatory regime. The trend was further accelerated by the 2020 pandemic, which heightened the need for these emerging technologies.
Finally, longer IPO periods in the tech sector meant that companies eventually debuted in the public markets as mega-cap growth shares.
2. Has it ever happened?
BofA cites a host of bubbles that have occurred throughout history, including the tulip speculation of the 1700s, the dotcom bubble of the 90s, and the housing and cryptocurrency frenzies of this century.
“Bubbles fueled by excessive leverage, democratization of markets and rampant speculation tend to end badly. But true disruptors can do well,” the report says.
3. How is it different from 2000?
A point of comparison was the dotcom bubble of the early 2000s, which produced a number of blue chip companies still listed today. But while that period ended with significant consolidation and losses for investors, the current tech rally differs in important ways.
The top seven companies today are much larger than many technology companies in 2000, indicating that they can afford to deal with tougher regulation.
Meanwhile, deeper pockets mean companies can capitalize more on the momentum of AI, as it tends to favor companies with data sets, install bases and subscriber pools. more important, wrote BofA.
4. What should investors be aware of?
The rally is not without risk. As these stocks grow, they are vulnerable to greater market saturation, prompting investors to sell in the event of an unpleasant surprise.
Shareholders should also be alert to Big Tech activity, as these companies tend to criss-cross markets and move between winners and losers — one example includes Microsoft’s new focus on cybersecurity.
And while helpful against competition, regulation can also hurt further growth.
Finally, investors should pay attention to the industry’s own demand: “Tech investment growth during COVID was similar to that of 2000, which was followed by consecutive years of negative revenue growth. “
5. How can investors manage risk?
Investors can expect opportunities to broaden beyond the seven mega-caps, and the equally-weighted S&P valuations will outpace them. However, these top seven companies are still poised to beat expectations for the average S&P 500 stock and are valuable long-term assets.
Investors should avoid expensive tech names that are too crowded and show low market gains. Instead, it pays to focus on healthy balance sheets and companies that dominate the market.
Read the original article on Business Insider