Quarterly Insights

by Gibson Capital April 25th, 2024

Stocks picked up in the first quarter of 2024 from where they left off last year. After a strong rally to end the year, U.S. and non-U.S. stocks returned 10.4 percent and 4.6 percent, respectively through the end of the first quarter. Insurance-linked securities also performed well. Bonds and real estate lagged as the Federal Reserve signaled a slower pace of interest rate cuts than the market previously anticipated.  These two asset classes generally are sensitive to changes in interest rates, and the new rate consensus has negatively affected bond and real estate prices.

The “Magnificent 7″

A small group of technology companies has been the driving force behind recent U.S. stocks returns. This group, dubbed the “Magnificent 7,” consists of Apple, Microsoft, Amazon, Nvidia, Alphabet (Google), Meta (Facebook), and Tesla. Remarkably, these seven companies have accounted for more than half of U.S. stock index returns since the beginning of 2022 and roughly 40 percent since the beginning of this year1 . Aside from their individual stock performances, it is their sheer size that makes the group so influential on the performance of the broad market. The 10 largest U.S. companies make up more than 30 percent of the S&P 500, a degree of market concentration not seen in decades.  

Your intuition probably leads you to conclude that concentration is riskier than diversification. A business that is dependent on one big customer is less resilient than a business with multiple product lines. The sports team with one star performer can be easier to stop or more susceptible to a bad night than the team that is more well-rounded. The same is true when it comes to the composition of an investment portfolio. If your goal is to preserve and grow your wealth, you want to avoid being reliant on the performance of just a few investments.

While many investors may agree with this logic in the abstract, the appeal of the Magnificent 7 and what they represent more broadly is significant. To many, these companies embody the innovation and dynamism of U.S. businesses notably lacking in other parts of the world, such as Europe. These companies also might represent the triumph of modern technology companies over stodgy “old industry” businesses. From these observations, it’s only a hop, skip, and a jump over to two related investment conclusions: 

  1. U.S. stocks outperform non-U.S. stocks.
  2. Growth-oriented technology stocks outperform the stocks of lower-growth businesses.  

These two statements are missing some important words: “have recently.” That additional context changes the investment implications in meaningful ways. U.S. stocks have recently outperformed non-U.S. stocks. U.S. stocks have not always outperformed non-U.S. stocks, and they very well may not outperform non-U.S. stocks in the future. Growth-oriented technology stocks have recently outperformed the stocks of lower-growth businesses. Stocks of companies with high expectations for future earnings growth actually have underperformed their slower-growth counterparts historically.  

Notice how easy it is to project what has happened recently onto what will happen in the future. The recent past feels like evidence of superiority. Yet this extrapolation misses an important aspect about how financial markets work. 

Expectations Matter 

The consensus of stock analysts is that the Magnificent 7 will grow their sales (revenue) at 12 percent per year (compound) through 2026, while the remaining 493 companies that round out the S&P 500 will grow their sales at just 3 percent per year 2 . Moreover, analysts expect the Magnificent 7 to turn more of their sales into profit by expanding their profit margins at a much greater rate than the not-so-magnificent 493. The Magnificent 7 may indeed meet these lofty expectations. For these stocks to outperform, however, they must beat these expectations. And because these seven tech giants comprise such a large portion of the U.S. market, they may have to beat expectations for U.S. stocks to outperform other geographic markets and for growth stocks to continue to outperform lower-growth companies.

Throughout market history, failing to meet high growth expectations after a period of sustained dominance has tended to be the rule rather than the exception for the world’s most successful companies. This risk may be under appreciated today because it hasn’t posed a problem in recent memory. Consider the stock market boom and subsequent bust of the late 1990s. That was 25 years ago! An investor turning 65 today may have had comparatively little invested in the late 1990s when they were just 40 years old. For many, their recollections of this period are confined to the spectacular flameouts of internet companies like Pets.com and Webvan that had little in the way of actual earnings. Great companies failing to live up to expectations is both less memorable and more impactful on the results of most investors. The following example comes from stock strategist David Kostin:

“In March 2000, Microsoft, Cisco, General Electric, Intel, and Exxon Mobil were the largest S&P 500 companies, comprising 18 percent of that index. Consensus forecasts showed the group growing sales at 16 percent (compound) over the next two years. They actually delivered just 8 percent (sales growth). The group went on to underperform the S&P 500 by 21 percentage points over the next 24 months.”

Numerous examples from financial market history prove it’s hard to stay on top. Star performers have to keep up not only with their business competition but also with growing expectations for their business performance. Up to this point, the stars of today have done so in magnificent fashion. If their performance continues, your portfolio will benefit. These companies are the largest individual stocks in our client portfolios. However, the success of your investment strategy is not predicated on the performance of a few select companies or even an entire asset class, like U.S. stocks. Your investment strategy anticipates changing leadership between asset classes and sectors, which means you’re not overexposed to a shifting investment landscape, and you’re already positioned to benefit from whatever comes next.

As always, we look forward to our next conversation.


1:  Goldman Sachs Global Investment Research

2: https://www.morningstar.com/news/marketwatch/2024020547/fate-of-the-mag-7-depends-on-their-ability-to-deliver-rapid-revenue-growth-in-2024-says-goldman-sachs

As Chief Investment Officer, Chris leads our investment research agenda as well as our portfolio management philosophy and client service initiatives. He is continuing our legacy of innovations to convey complex advisory concepts to clients and professional audiences alike. Chris has professional experience ranging from high-net-worth portfolio management to comprehensive financial planning. As an investment advisor, Chris manages all aspects of client relationships.

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