Warning about US stocks for South African investors

The dominance of the so-called Magnificent 7 stocks is waning as a broader range of companies and sectors outperform them, yet many portfolios remain heavily concentrated in these tech giants.

This is the view of Schroders’ head of strategic research, Duncan Lamont, who said this means investors are missing out on diverse opportunities at more attractive valuations.

For years, the Magnificent 7 – Nvidia, Apple, Microsoft, Alphabet (Google), Amazon, Meta (Facebook), and Tesla – dominated global stock market performance. 

However, this year, a significant proportion of global companies have outperformed most of the Magnificent 7. 

“This isn’t just down to China’s recent revival. A remarkably similar proportion have also outperformed them in the US,” Lamont said.

“Don’t get me wrong, many of the Magnificent 7 are fantastic companies. Some have compounded returns for so long, even as they’ve grown ever larger, that naysayers have been forced to eat humble pie regularly.”

“The point I want to emphasise here is not that they are bad investments, just that it is short-sighted to suggest they are the only good investments.” 

Lamont emphasised that all of these companies have delivered strong returns this year. However, it is important to know that others have done even better.

He said a similar trend appears when looking at the sector level. Across the major markets, the top performer this year has been the US utilities sector, with an impressive 32% gain. 

Financials have also performed well in many parts of the world. Even Japanese and UK industries have performed remarkably well. “There’s more to markets than tech stocks,” Lamont said.

“The theme here is one of broadening out. Whereas last year, returns outside of the Magnificent 7 were mediocre in comparison, this year there has been a wealth of, often overlooked, opportunities.”

The table below shows the Magnificent 7’s performance so far this year.

Lamont explained that this goes beyond share price movements. Looking 12 months ahead, nearly half of listed companies in Europe and Japan are forecast to deliver double-digit earnings per share growth in local currency terms. 

Figures for emerging markets are even higher, as more than 60% are forecast to deliver double-digit growth, but this is because these are nominal figures, and inflation is much higher in many emerging markets.

“The problem for equity investors is that, although performance is broadening out, their portfolios are not,” Lamont said.

“The six largest US companies make up more of the global stock market than the combined weight of the next six biggest countries combined: Japan, UK, Canada, France, China, and Switzerland.” 

“Six stocks, six countries. Their 18.1% weight is the same as the 2,000 smallest companies in the global market combined.”

He explained that this concentration means a lot of risk in barely a handful of stocks with scant exposure to the broader opportunity set. 

In addition, these other companies are much cheaper in valuation terms, both within the US and globally, compared to the Magnificent 7. 

Lamont said the broadening out of performance away from the Magnificent 7 should not be a surprise. 

It is rare for a company that is a top 10 or even top 100 performer to stay among the top for consecutive years. 

“Prices get bid up too high, baking in overly optimistic expectations for growth. Others get neglected, their share prices languishing, baking in overly downbeat expectations,” he said.

“This can go on for a period as more investors get sucked into the hype cycle until, eventually, the elastic snaps back. The past winners are overtaken by the neglected and fall down the performance rankings.”

He said that, historically, high concentration in a few top stocks has often signalled future underperformance compared to the average market return. 

This trend presents new opportunities in smaller and neglected companies, yet many portfolios remain skewed towards large-cap tech stocks, especially in passive investments that now constitute a record-high portion of global assets under management.

“The proportion of assets managed passively around the world has never been higher. The reasons for this are well-known and understandable,” Lamont said. 

“But it is worth investors at least pausing to reflect on what that really means in today’s market. Six stocks, six countries. Six stocks, 2,000 stocks.” 

“There are tremendous opportunities across global stock markets today, but passive portfolios have rarely had so little exposure to them.” 

“Individual decisions may be understandable but I do worry that the precise timing of the influx may be inopportune. Time will tell whether I am right.”