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Will The Magnificent Seven Ride Again??

Will The Magnificent Seven Ride Again??

January 10, 2024

The Magnificent Seven is a 1960 film directed by John Sturges. The movie is a Western-style remake of the 1954 Japanese film Seven Samurai. The ensemble cast includes Yul Brynner (my wife Rachel’s favorite, notice how his hairstyle resembles mine), Steve McQueen, Charles Bronson, Robert Vaughn, Brad Dexter, James Coburn, and Horst Buchholz as a group of seven gunfighters, hired to protect a small village in Mexico from a group of marauding bandits led by the perpetual bad guy, Eli Wallach (the Ugly, from The Good, The Bad and The Ugly).

Source: Moviepedia

The movie turned out to be both a critical and commercial success and is regarded as one of the greatest films of the Western genre. It spawned three sequels…Return of the Seven (1966), Guns of the Magnificent Seven (1969), and The Magnificent Seven Ride! (1972). A YouTube clip from the trailer for the original movie is included below for those of you who have not seen the film, or for those of you who would just like to reminisce.

The Magnificent Seven (1960) - Official Trailer

Through the first eleven months of this year, a different Magnificent 7 has consumed many of the headlines in the investment and financial markets. It seems that seven stocks that all have ties to technology and especially artificial intelligence have had outsized performance when compared to the broader stock market as measured by the S&P 500. As you can see in the chart below from our friends at First Trust Advisors, more than 70% of the return of the S&P 500 has been driven by just these seven stocks. This means that the other 493 stocks in the index contributed less than 30% of the total return during this time.

The outsized performance of these seven stocks has also led to them having an outsized weighting in the index. Remember that the S&P 500 is a market-cap-weighted index. This means that the larger the value of a company's outstanding stock, the larger the weighting in the index. As of the end of November, the Magnificent 7 make up nearly 30% of the market capitalization of the index. This once again means that the other 493 stocks make up approximately 70% of the index's weight.

As you can see in our second chart below, this has also led to the fewest number of stocks outperforming the index since the late 90s heyday of the dot-com bubble. It has often been said, “History does not repeat itself, but it sure does rhyme”. We know in the years following the bursting of the dot-com bubble, other stocks and other sectors rotated into leadership, and it was many years before the technology darlings of the previous cycle came back into favor.

 

Finally, we can observe that the extraordinarily strong performance of the Magnificent 7 has also led to extraordinarily high prices for them. The PE ratio for these seven stocks is now in the mid-30s, nearly double the PE ratio of the other 493 stocks, as you can see in our final chart below.

As we have shared with you many times before, trees do not grow to the sky. The price you pay for something matters. The higher the initial price you pay for something, the lower the future returns you should expect. We have seen this play out in the markets many times over the last 25 years. It happened during the dot-com bubble of the late 90s, the real estate bubble of the mid-2000s, and even the bond market bubble which burst in a very ugly way as the Fed started raising interest rates aggressively in 2022.

Often the antidote for high prices in one sector is lower prices elsewhere, in unloved and underinvested asset classes which people have been ignoring. This is why the CFPs of Impel Wealth Management preach diversification and rebalancing so that our client's portfolios do not get out of alignment with their long-term financial planning goals.

So, will The Magnificent 7 ride again?  While the 1960 movie spawned multiple sequels, we do not see this pattern playing out in the market historically. Eventually, valuations always matter, and another sector rides to the front of the pack. We thought this was an important message and reminder as we turn the corner into a new year, with new opportunities. We will continue to do our best to stay disciplined with our diversification to help you, our trusted friends and clients, achieve your family's financial goals. It is what drives us as we continue “Moving Life Forward”.

© 2024 Jesse Hurst

The views stated are not necessarily the opinion of Cetera and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.

Investors cannot directly invest in indices.