PSG warns investors the Magnificent 7 bubble will burst

Local asset manager PSG has warned investors that the Magnificent Seven stocks of Apple, Microsoft, Google, Meta, Amazon, Nvidia, and Tesla remain priced for perfection. 

This means that any external shock or even just growth below expectations may result in a significant selloff and investors losing money. 

The Nasdaq was up 26% mid-July since January 2024, and the S&P 500 index was up more than 18% over the same period. 

PSG chief investment officer Adriaan Pask said both indices have been powered upwards by tech stocks like Nvidia, Microsoft, Alphabet, Amazon, and Meta. 

However, things have changed quite dramatically over the last few weeks. Both the Nasdaq and the S&P 500 index are down 13% and 8%, respectively, erasing more trillions in market capitalisation.

The market’s meteoric rise has been behind investors’ betting on the artificial intelligence (AI) ecosystem. 

Nvidia has been the poster child for this trade, and its share price is up 288% over the last year up to mid-July 2024 – making it the world’s most valuable company with an eye-watering Price-to-Earnings (PE) multiple of 70 times at that point. 

Since then, Nvidia has lost almost 30% of its value in two weeks. Investors remain concerned that AI will not have the benefits it promises, with incremental productivity gains coming in place of a giant leap. 

Pask explained that the P/E ratio is a proxy for the market’s assumptions about a company’s long-term growth rate. 

For instance, a P/E of 5 suggests a 5% annual growth rate, which is modest. Conversely, a P/E of 70 implies a 70% annual growth rate. 

That would mean that Nvidia’s market capitalisation will be larger than the GDP of many countries in a decade if it keeps growing at the current rate. 

“Given the above, we believe we are currently in a tech-stock bubble that may be on the verge of bursting,” Pask said. 

“Although it’s challenging to determine our exact position in the cycle, the indicators are becoming increasingly evident.” 

Why there is a bubble

Pask explained that the inherent uncertainty in the tech sector and inaccurate forecasting make the formation of a bubble possible. 

“There’s often little concrete data for investors to rely on for accurate future projections. Big ideas in tech, especially in areas like AI, capture our imaginations and are heavily marketed, which can cause people to get overly excited.”

While AI, for example, is a significant technological development, there is little understand of how it will impact the broader economy and boost productivity. 

This lack of deep understanding, combined with the hype, creates uncertainty.

“Therefore, the bubble we are referring to is not in the technology but in the market’s valuation of the tech companies that create this technology.” 

It is possible to have substantial and transformative growth in technology that changes consumer behaviour, similar to the introduction of the internet during the dot-com bubble.

While the internet’s impact has indeed been profound, the initial valuations were overly inflated.

The problem lies in the market’s focus on immediate, first-order benefits without considering the deeper, second-and third-order effects, where PSG believes the real value lies. 

This tendency to focus on immediate gains can lead to overly rich valuations, which is a characteristic of a bubble.

Looking at the dot-com bubble example, investors were piling into the infrastructure or the software around the internet and computing and dot-com companies. 

However, the biggest beneficiaries ended up being the companies that could harness the power of the internet into their business models, such as Meta and Google. 

“Considering Nvidia against this backdrop, you realise that it is priced for perfection and that no ‘margin of safety’ exists for the share.” 

“No company is entirely immune to competition or regulatory scrutiny, yet Nvidia’s pricing reflects neither. Only growth is factored in, with an unrealistic assumption of indefinite sustainability.”

Currently, these valuations are just too stretched for safe investing, Pask warned. 

It’s important to recognise that more research is needed to accurately assess these businesses’ true value, as current information is often insufficient. 

Investors must also remember that they are not deprived of investment opportunities. Many great businesses are offering 10% earnings growth per annum, high single-digit dividend yields and robust balance sheets, Pask said. 

These companies’ proven business models provide safer paths to achieving your financial goals. There’s no need to chase speculative investments that could end poorly.