Investors beware: 'Magnificent Seven' are starting to resemble 'Nifty 50' stocks that got crushed in the 1970s market crash

By Joseph Adinolfi

What do the "Magnificent Seven" stocks of today and the "Nifty 50" names of the early 1970s have in common? More than you might expect, according to one Wall Street strategist.

Apart from representing extreme levels of concentration in the U.S. stock market, the companies' earnings multiples appear comparable, Apollo Global Management's Torsten Slok recently showed. Slok also compared Magnificent Seven multiples to the S&P 500 information-technology sector of the dot-com era and found some similarities there as well.

Investors should be eager to glean any lessons that they can from the Nifty 50 era, given what happened to those stocks during the bear market of 1973 and 1974. During the punishing two-year stretch, the S&P 500 SPX fell by more than 40%, according to FactSet data, with shares of many of those market leaders seeing even larger declines.

The issue of whether their high valuations were ever truly warranted remains a subject of debate among academics studying the financial markets to this day.

As Slok sees it, lofty valuations for the Magnificent Seven should make investors think twice about investing in the broader S&P 500, given that these stocks now make up nearly one-third of the index's aggregate market value, according to Bank of America.

"The divergence between the S&P 7 and the S&P 493 continues ... and investors buying the S&P 500 today are buying seven companies that are already up 80% this year and have an average [price-to-earnings] ratio above 50," Slok said in a brief emailed comment accompanying two charts that he shared with the press and Apollo clients.

"In fact, S&P 7 valuations are beginning to look similar to the Nifty Fifty and the tech bubble in March 2000," he wrote.

Why should investors be concerned about valuation? Because over the long term, valuation and future returns tend to be inversely correlated, as shown by the chart below, produced by a team of analysts at BofA.

The higher the valuation today, the more muted the gains will be over time - although there is still plenty of room for valuations to continue to climb over the short term.

The Nifty 50 was, to use a description employed by Wharton professor emeritus Jeremy Siegel in a 1998 article in the AAII Journal, "a group of highflying growth stocks that soared in the early 1970s, only to come crashing to earth in the vicious 1973-74 bear market."

The episode supposedly made investors wary of investing in stocks with excessive valuations. But whatever lessons investors learned were clearly forgotten by the time the dot-com craze began two decades later.

"After the 1973-74 bear market slashed the value of most of the 'Nifty50,' many investors vowed never again to pay over 30 times earnings for a stock," Siegel wrote.

Siegel has not yet responded to a request for comment from MarketWatch.

During their heyday, the Nifty 50 stocks were often called "one decision" stocks, meaning they should only be bought, never sold. Given the Magnificent Seven's performance over the past 15 years, selling them has also rarely looked like a smart move in hindsight.

But to determine whether a comparison between the two groups is truly warranted, it helps to look at why the Magnificent Seven names have performed so well this year.

For starters, the seven companies generally enjoy strong balance sheets, reliable cash flows and growing sales. They also suffered from a punishing bear market in 2022, which brought their valuations to levels that seemed compelling to many. Finally, it is widely believed that these seven giants are poised to be the biggest beneficiaries of the artificial-intelligence boom.

Because of this, many on Wall Street agree that the Magnificent Seven group deserves a higher multiple than the S&P 500 index, which currently trades at roughly 22 times trailing 12-month earnings, according to FactSet data.

But determining exactly how large this premium should be is much trickier, according to Carlos Dominguez, chief investment officer at Element Pointe Family Office.

This task is complicated by the fact that the Magnificent Seven companies are far less homogenous than their shared sobriquet might suggest. Some members enjoy much stronger growth prospects than others.

For example, Nvidia's reported revenue was up more than 200% year over year during the third quarter to $18.1 billion in revenue, according to a company press release.

While this might already be reflected in its multiple, such a rapid pace of revenue growth makes the company's valuation seem much more reasonable, Dominguez said, even if it likely won't be able to sustain this pace of sales growth forever.

Meanwhile, valuations for other members of the Magnificent Seven, like Tesla Inc. or Apple Inc., are harder to justify, Dominguez said.

"You can make a case that maybe Apple trades rich, and to me that is one of my least favorite of the group. I'd say Apple and Tesla - I think Tesla has been an amazing stock, but I think the best returns are behind it," he said.

"I think these stocks as a group look extended, but I don't see them crashing," he added.

Also read: Here's why Nvidia is a compelling stock when compared with the rest of the 'Magnificent Seven'

Slok isn't the only Wall Street strategist who has employed the Nifty 50 comparison lately.

A team of equity strategists at BofA have repeatedly pointed out that, thanks to the Magnificent Seven, U.S. stocks are outperforming their international peers by the widest margin going back to the 1950s, surpassing previous peaks from the dot-com and Nifty 50 eras.

Some examples of Nifty 50 stocks culled from a list accompanying Siegel's article are Philip Morris Cos., Pfizer Inc. (PFE), Bristol-Myers Squibb Co. (BMY), Gillette Co., Coca-Cola Co. (KO), Merck (ID:MERK), Heublein Inc., General Electric Co. (GE), Texas Instruments Inc. (TXN), International Business Machines Corp. (IBM), Xerox Holdings Corp. (XRX) and Polaroid Corp. There are a few different lists, many with slight variations.

The Magnificent Seven are generally regarded as Microsoft Corp. (MSFT), Apple Inc. (AAPL), Nvidia Corp. (NVDA), Alphabet Inc. (GOOGL), Meta Platforms Inc. (META), Amazon.com Inc. (AMZN) and Tesla Inc. (TSLA).

-Joseph Adinolfi

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12-02-23 1010ET

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