By Ryan Vlastelica on January 12, 2024 at 6:43 AM EST
Updated on January 12, 2024 at 9:46 AM EST
If 2023 was all about the Magnificent Seven on Wall Street, this year is poised to usher in a broader array of winners.
That’s the consensus among investors, with smaller and more diverse companies seen to offer twice the return potential of the broader Nasdaq 100 index, according to data compiled by Bloomberg.
With traders betting on a soft landing and Federal Reserve interest rate cuts, riskier small-cap and unprofitable firms are seen as more attractive. That’s after a year in which Apple Inc., Microsoft Corp., Amazon.com Inc., Alphabet Inc., Nvidia Corp, Meta Platforms Inc., and Tesla Inc. were a go-to trade: regardless of market conditions, they offered both offensive and defensive characteristics.
Last year, “if you didn’t own the top seven or eight stocks, you weren’t able to participate in most of the returns. Investors should be cautious about assuming that’s the way it will be in 2024 as well,” said James Demmert, founder and chief investment officer at Main Street Research.
The megacap effect on last year’s returns is difficult to overstate. The Bloomberg Magnificent 7 Price Return Index more than doubled in 2023, contributing to a gain of 54% for the Nasdaq 100 Index. An equal-weighted version of that index, however, gained less than 33%, while an index of small-cap tech rose less than 21%.
The Nasdaq 100 Index rose 0.2% on Friday, while the Magnificent 7 index fell 0.4%. The small-cap tech index gained 1.1%.
Friday’s action is the latest sign of how this trade is reversing. Both small- and mid-cap tech sector indexes have kept pace since the end of October, and measured as a ratio against its equal-weighted counterpart, the Nasdaq 100 peaked in November and has subsequently dropped. Improvement in equal-weighted indexes is seen as a bullish signal.
Based on the average analyst price target, Wall Street sees a return potential of about 13% for small-cap tech, according to data compiled by Bloomberg. For the overall Nasdaq 100, it is less than 7%.
In a measure of how short-term market breadth has been improving, roughly 80% of Nasdaq 100 components are above their 50-day moving averages, compared with an October low below 13%, while 80% are above their 200-day averages, double a recent low.
The shift largely coincides with changing views over Fed policy and more favorable bond market conditions. The yield on the 10-Year Treasury is down from its October peak to below 4%. Higher rates raise the cost of financing and hurt the present value of earnings expected in the future, and tend to act as an outsized headwind on smaller and higher-valuation stocks.
“Such stocks are more dependent on the economic cycle than the Magnificent Seven, so a soft landing is more beneficial to them overall, especially as they play catch-up after last year,” said Damian McIntyre, portfolio manager and senior quantitative analyst at Federated Hermes. “At the same time, AI was a key driver for the seven, but as more companies are able to enter into and benefit from that space, it should help the rally broaden out.”
The potential easing of the rates headwind comes at a time when tech beyond the megacaps already looks like a relative bargain. The index of small-cap tech trades at 16.6 times estimated earnings, a discount to its average over the past decade. The Magnificent 7 index, meanwhile, has a multiple of 28.
Still, investors are broadly positive on megacap tech, given its durable growth prospects and proximity to the AI growth story, especially as the latest inflation data underlines how the path to lower rates may not be as smooth or rapid as some bulls expect.
“Tech should continue to be in a very vibrant bull market in 2024, but it is one that will broaden out across the sector, and not just be confined to the top names,” said Demmert. Still, he added, “the Magnificent Seven have to be a staple of your portfolio.”
Read the full article here: https://bloom.bg/492g3V5